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94th Congress 1 
2d Session J 


BUDGET,,"! _ 

( W 

Staff Studieb f tr lF««al 1977 


Inflation - 1 

Employment 25 

Assistance to State & Local Governments.- 61 

Retirement & Disability Programs 87 

U.S./U.S.S.R. Military Spending 125 

JUNE 28, 1976 

Printed for the use of the Committee on the Budget 



EDMUND S. MUSKTE, Maine, Chairman 

ERNEST F. HOLLINGS, South Carolina 
ALAN CRANSTON, California 
JOSEPH R. BIDEN, Jr., Delaware 
SAM NUNN, Georgia 

J. GLENN BEALL, Jr., Maryland 

Douglas J. Benxet, Jr., Staff Director 

John T. McEvoy, Chief Counsel 
Robert S. Boyd, Minority Staff Director 
W. Thomas Foxwell, Director of Publications 




Letter of Transmittal vii 


Preface * 3 

I. Summary 5 

II. Costs and prices under direct Federal control: 

A. The Administration's budget proposals for fiscal 1977 6 

B. Direct price effects of other Government programs 10 

III. The effect of the budget on inflation and unemployment: 

A. The outlook 13 

B. The impact of an income tax cut on inflation and unemploy- 

ment 15 

C. The impact on inflation and unemployment of direct cuts in 

costs 16 

Appendix 18 


Annual rate i of cost increase 8 

Cost inflation in the budget 10 

Inflation and unemployment on the 2 CBO growth paths 14 

Estimated effect on price level and unemployment of various programs 

to reduce private costs 17 

The composition of the percent of inflation 20 

Charts and graphs: 

Historical relation between inflation and unemployment 22 


Preface 27 

I. The problem and alternative solutions: 

A. The problem 29 

B. Goals 30 

C. Basic approaches and decisions 30 

II. Growth: How fast? 31 

III. The "direct response" of the Federal budget to unemployment: 

A. A variety of instruments 36 

B. Enhanced employability and incentives 41 

C. Income maintenance for the employable 44 

D. Direct employment - 49 




Appendix 55 


Unemployment and employment under two economic growth paths. . 29 
Difference in employment by age, sex, and race by achieving 6 percent 

rather than 5 percent average real output growth 33 

Unemployment rates by race, sex, and age during the current recession. 34 

Federal anti-employment instruments 37 

The Federal direct response to unemployment 39 

"Direct response" budget (Path A) 40 

"Direct response" budget (Path B) 40 

Demographic changes in the labor force and unemployment rolls 41 

Outlays from income support programs for the employable, 1976-1981 _ 45 

Changes in characteristics of unemployment 55 

Changes in the budget's direct response to unemployment from a 

targeted public employment program 58 

Charts and graphs: 

Distribution of the civilian labor force and recession-induced unem- 
ployment among age groups 32 

Unemployment rates of household heads 35 

^Number of unemployed household heads 35 

Distribution of the anti-unemployment budget outlays 38 


Preface 63 

I. Introduction and summary 65 

ft. Current programs and the President's proposals 66 

III. Objectives of Federal assistance 70 

IV. Fiscal year 1977 budget issues and options: 

A. General revenue sharing 74 

B. Anti-recession assistance 75 

C. Law enforcement assistance 80 

D. Exclusion from Federal income taxes of interest on municipal 

bonds 81 

E. The President's proposals for categorical grants 82 

V. Conclusion 85 


Federal grants to State and local governments (outlays) 67 

Grant outlays by function 68 

Cost of major Federal tax expenditures aiding State and local govern- 
ments, fiscal years 1967 and 1976 68 

Federal grants-in-aid outlays by function 70 

Comparison of anti-recession programs- 77 

Comparison of President's policy for block grants proposals 83 





Preface 89 

I. Summary 91 

A. Social security 92 

B. Medicare 93 

C. Federal employee retirement 93 

D. Other legislation 94 

II. Importance of retirement and disability programs to fiscal policy 94 

III. Relationships among retirement and disability programs 99 

IV. Major policy issues: 

A. Financing social security in the short run 101 

B. Long-run social security issues: Decoupling and financing 108 

C. Protection against catastrophic health care costs 109 

D. Federal service retirement and disability 111 

E. Other pending legislation 116 


CBO path B projections of current services outlays for retirement and 

disability programs, 1975-81 95 

Caseloads and costs of Federal income assistance programs 97 

Projections of the receipts and disbursements of OASDI trust funds, 

1975-81 102 

Savings under military retirement options,, 116. 

Charts and graphs: 

Overlaps in beneficiary groups, fiscal year 1975 99" 

Overlaps in beneficiaries age 65 and over 100 


Preface 127 

I. Introduction and summary 129 

II. Soviet foreign/military policy 132 

A. External security situation 134 

B. Internal security considerations 139 

III. Usefulness of U.S. /U.S.S.R. military spending comparisons 143 

A. Criticism of budget comparisons 143 

B. Costing methodologies 144 

C. Are the estimates useful? 146 

IV. U.S. /U.S.S.R. quantitative force comparisons: Cost implications for 

FY 1977 budget 148 

A. Strategic offensive forces 149 

B. Strategic defense forces 152 

C. Theater nuclear forces 152 

D. General purpose forces 154 

E. Western Pacific/ Asia deployment 165 




U.S./U.S.S.R. strategic delivery vehicles 149 

U.S./U.S.S.R. strategic weapons 149 

U.S./U.S.S.R. general purpose forces 154 

NATO/Warsaw Pact balance 154 

United States — 

ICBM 1977 budget proposals 150 

Submarine-launched ballistic missiles 150 

Strategic bomber forces and related systems 151 

Strategic defense forces 152 

Tank forces 155 

Artillery 156 

Helicopters 157 

Surface ships 159 

Surface combatants — weapons and equipment 160 

Attack submarines 161 

Air Force tactical air programs 162 

Navy tactical aircraft 163 

Tactical air missiles 164 

Airlift/sealift forces 165 

Charts and graphs: 

U.S./U.S.S.R. nuclear capabilities— 1975 152 


To Budget Committee Members: 

The papers published herewith were prepared, as you know, by the 
Budget Committee staff in connection with the Committee's considera- 
tion of the First Concurrent Resolution for Fiscal 1977. Each deals 
with one of the major underlying decisions we confronted in connection 
with the fiscal 77 resolution. I believe they should be available for 
further use by our Committee, and for use by other committees and 
Members as the Senate considers specific fiscal 77 spending legislation. 

Government Policies To Reduce Inflation identifies policy decisions 
such as proposed changes in payroll taxes and certain subsidies that 
will directly affect prices. These decisions will have a more important 
influence on the rate of inflation in fiscal 1977, while physical and hu- 
man resources are under-utilized, than will the rate of economic 

The relationship among overall fiscal policy, spending for employ- 
ment and education, and income maintenance programs is investi- 
gated in the paper entitled Employment. 

Approximately 45 percent of the Federal programmatic response to 
unemployment is in the form of financial assistance for the unem- 
ployed, primarily unemployment compensation. Another 43 percent is 
spent on education and training programs that increase employability. 
Only 12 percent is for programs such as public employment, public 
works, and countercyclical revenue sharing that directly increase 

The paper describes a public employment program, targeted on low- 
income families who are receiving unemployment compensation and /'or 
welfare, providing relatively low salaries for only 12 months. The 
analysis shows that the net budget cost (i.e., net addition to the deficit) 
would be between $2,100 and $2,500 per job per year. 

Federal Assistance to State and Local Governments is an effort to 
place key fiscal 1977 spending decisions on Federal grants-in-aid in the 
context of broad Federal-State-local fiscal relations. State and local 
government are a significant sector of the economy, accounting for over 
15 percent of GXP. A substantial portion of their revenue — on the 
order of 22 percent — comes from Federal grants, which are found in 12 
of the 17 budget functions. Thus Federal grants affect a wide range of 
State and local government activities. They also affect the response of 
State and local budgets to economic cycles, and consequently, the ef- 
fectiveness of Federal stabilization policy. 



Trends and Issues in Federal Retirement and Disability Programs de- 
scribes the major fiscal issues Congress faces in the provision of cash 
and health-care benefits to the aged, retired, disabled, and survivors. 
These programs — which include social security, medicare, civil 
service and military retirement systems, supplemental security income 
(SSI), and veterans' compensation and pension benefits — account for 
36 percent of all Federal outlays ($150 billion in fiscal 1977 out of $413 
billion total). The revenues collected for social insurance trust funds 
from which most of these benefits are paid will amount to $107 billion 
in fiscal 1977, or 30 percent of the total $362 billion. 

The most pressing issue concerns the possibility of a short-term 
deficit in the social security trust funds. The paper indicates that the 
chance of such a deficit materializing is far from certain and there are 
many ways to deal with such an eventuality. The paper also describes 
the long-term financing problem and how it relates to various short- 
term approaches. 

U.S.-U.S.S.R. Military Spending explores some of the major policy 
pressures behind the substantial growth in strategic and general pur- 
pose forces provided in the fiscal 1977 budget. These pressures include 
the security perceptions of the Soviet Union and the comparative force 
strengths of NATO and the Warsaw Pact as well as that of the two 
super powers themselves. The report also analyzes the usefulness of 
comparing U.S. and U.S.S.K. military spending in evaluating the 
adequacy of the U.S. defense budget. 

These studies have been prepared by the Senate Budget Committee 
staff with the assistance of the Congressional Budget Office. The 
studies were undertaken to aid the Budget Committee in the decisions 
it must make in these areas with respect to fiscal policy and budget 

Nothing in these studies should be interpreted as representing the 
views or recommendations of the Budget Committee or any individual 
Member thereof. 


Edmund S. Muskie, 





This paper was prepared to aid the Senate Budget Committee in 
formulating the First Concurrent Resolution on the Budget for Fiscal 
Year 1977. 

The paper was prepared by Donald Nichols and Edmond Haggart 
with the assistance of Karen Schubeck and Martin Asher of the Senate 
Budget Committee staff. Michael Owen and Frank deLeeuw of the 
Congressional Budget Office provided the econometric analyses. 

Edmund S. Muskie, 





I. Summary 

Fiscal policymakers are well aware of the short run trade-off between 
inflation and unemployment. The threat of renewed inflationary 
pressures is a deterrent to policies which would hasten the return to 
full employment and full production. In the present unusual circum- 
stances when both unemployment and inflation are high, policies are 
needed which will cut prices and stimulate recovery simultaneously. 

This paper suggests that policy opportunities of this kind are avail- 
able through modest changes in the 1977 budget. Specifically, the 
President has proposed to change several prices and costs which are 
now directly controlled by the Federal Government. Some of his 
proposed changes would increase prices, such as the 0.3 percent in- 
crease in Federal social security payroll taxes and the increase in 
unemployment insurance taxes. Some proposed changes would lower 
prices, such as his proposals for Federal pay and Medicare cost 

Taken together, these changes, upon which Congress must act this 
year, can reduce the general price level by more than one-half of 1 
percent, compared with what would otherwise be. Additional oppor- 
tunities for price cutting by the Federal Government could reduce 
prices by another one-half percent at least, without considering 
secondary effects of price reductions on wage rates. 

These proposals also have an indirect effect on prices through their 
effect on economic activity. A cut in payroll taxes, for example, would 
reduce unit labor costs and therefore tend to reduce the rate of in- 
flation; but it would also stimulate economic activity, and this would 
tend to cause prices to rise. Both effects are considered here. Inflation 
caused by direct changes in prices or costs is called cost inflation, while 
that caused by changes in economic activity is called demand inflation. 

Section 1 examines the effect of some Federal policy options on cost 
inflation. Section 2 addresses the effect of these price-cutting options 
on demand inflation and compares their stimulative consequences with 
those caused by equivalent cuts of personal income taxes. 

The price cutting options are shown to have a more favorable effect 
on both prices and jobs. The model used here suggests that there are 
feasible policies that will cut prices by eight-tenths percent in the first 
year and unemployment hy over 0.4 percent in the second year. The 
disadvantages of using the price system in this fashion are noted. 



The options in this paper are considered independent from their 
effect on the Federal deficit. The conclusion is that cost cutting 
policies which would reduce Federal revenues by $10 billion have a 
more favorable impact on inflation and unemployment than, for 
example, a personal income tax cut which would reduce Federal 
revenues by the same amount. Moreover, it should be noted that a 
policy to reduce costs and inflation directly will permit adoption of 
more stimulative fiscal and monetary policies that will also reduce 
unemployment more quickly.* 

II. Costs and Prices Under Direct Federal Control 


The President's fiscal 1977 budget proposal suggests changes in 
many prices and costs. These are outlined here and an estimate of their 
impact on inflation is given. 

Payroll Taxes 

The President proposed that the social security payroll tax be 
increased by 0.3 percent on both employers and employees on January 
1, 1977. This is estimated to yield $3.3 billion in fiscal 1977 (in the 
first 9 months of 1977), and $4.4 billion over the full year. That half 
of the tax which is paid by employers is an increase in labor costs, and 
in the short run these costs are usually passed on to consumers in the 

* Minority footnote: 

A strong word of caution is required about concluding that fiscal stimulus 
in addition to that resulting from these policies should be adopted. The 
favorable short-run effects of these policies on inflation does not mean it is 
safe to apply still more stimulus — to get back to the original inflation rate and 
benefit from doubly improved real growth. 

There are three reasons for this caution: 

(a) The quantitative reductions in the rate of inflation are rather 

uncertain. This is merely a realization that the numbers are best 
estimates. If not increasing the unemployment payroll tax reduces 
the rate of inflation by 0.25 of a percentage point, this does not 
mean that added stimulus totaling a 0.25 increase in the infla- 
tion rate — by rule of thumb giving 0.5 added reduction in the 
unemployment rate — should be adopted. We can, however, safely 
conclude that adopting such a policy can be expected to produce 
at least as much real growth as tax reduction producing deficit 
of equal magnitude. In addition, the rate of inflation can be ex- 
pected to be lower. A policy that would have similar effects and 
was not mentioned in the paper is a wage tax credit. 

(b) The reduced rate of inflation resulting from use of policies that 

influence prices directly may be only a short-run phenomenon; 
the longer-run effects on the rate of inflation will be considerably 
less, possibly zero. Therefore, to apply stimulus in addition to 
that provided by the direct price policy may well result in a higher 
rate of inflation in the longer run. 

(c) The short-run trade-off between inflation and unemployment is not 

constant throughout the possible range of unemployment rates and 
real growth rates. In general, the lower the unemployment rate or 
the more rapid the rate of real growth, the greater will be the 
increase in the rate of inflation from added budget/or monetary 
stimulus. Therefore, the added stimulus in addition to that pro- 
vided by the direct price policies would affect that inflation rate 
more than it would in the absence of the direct price policies. 


form of higher product prices. The extra $2.2 billion in costs represent 
about 0.2 percent of employee compensation in calendar 1977. 

The proposed increase in the unemployment insurance tax would have 
a similar effect on costs. This proposed tax increase of $2.8 billion 
($2.1 billion in fiscal 1977), will be paid entirely by employers and 
would raise labor costs by a full quarter of a percent. 

The speed with which these cost increases would be transformed into 
price increases is uncertain. One recent study suggests that 75 percent 
of the increase would be passed on in the first year. 1 

There is also some evidence that firms maintain their traditional 
profit margins on cost increases of this kind. If this is the case, the 
long-run effect on prices could be greater than if the costs were simply 
passed through to consumers. 

Ignoring the markup effect, the Gross National Product deflator 
would increase by 0.19 percent in calendar 1977 as a result of the 
proposed increases in payroll taxes and by more than 0.26 in the long 
run. The effect on the Consumer Price Index — a better measure of the 
cost of living — would be slightly larger. 

The President's proposals to reduce corporate and personal income 
taxes may offset to some extent the effect on prices of the increases 
in payroll taxes. The evidence, however, does not suggest that this 
offset will be significant, at least in the short run. 

Pay Increases for Federal Employees 

The President has proposed to limit Federal pay increases to 5 
percent in October 1976. Assuming that comparability requirements 
would call for an increase of about 8.5 percent by that date, and 
assuming further that restoration would have been made of the 
remaining 3.7 percent increase that was denied in October 1975, this 
proposal would keep Federal salaries $3.5 billion below the level they 
would otherwise attain. 

Since Federal pay increases affect the Gross National Product 
deflator but not the Consumer Price Index, the effect of this proposal 
on the measured rate of inflation depends on which index is being 
used. No one's cost of living will be lower as a direct effect of the pay 
restraint. Yet the visibility of the Federal pay raise suggests that it 
may have a significant effect on other wage decisions. Thus the effect 
of pay restraint on the cost of living is indirect and its size is not 
estimated here. Its omission does not imply that the indirect effect 
would be insignificant. 

The GNP deflator would be 0.19 percent lower if the President's 
proposal to restrict wage increase to 5 percent were adopted than 
with no pay restraints. 

User Taxes 

The President has proposed to increase a wide variety of prices and 
taxes that are levied on the users of government facilities. 

Postal rates would rise by $307 million more than if the subsidy 
to second-, third- and fourth-class mail were extended at current 
rates. The Postal Service has requested the extension. 

1 Charles L. Schultze, "Falling Profits, Rising Margins and the Full Employ- 
ment Profit Rate," Brookings Papers on Economic Activity, 1975:2 pp. 449-469. 


Mass transit subsidies would be reduced. The President has pro- 
posed that only 50 percent of the funds provided to localities for 
mass transit aid in fiscal 1977 be used to subsidize fares. It is estimated 
that 90 percent of the $648 million requested for transit formula 
grants would have been used for fare subsidies without this restriction. 
Fares will be $258 million higher because of the restriction. 

The sum of all user tax increases of this kind would be more than 
$700 million. 2 If these costs were passed through to users with no 
markup, the GNP deflator would increase by 0.04 percent. 

Medical Care 

The President has proposed to limit the cost increases for medical 
care that can qualify for reimbursement under Medicare. Hospital 
cost increases of 7 percent and physician fee increases of 4 percent 
would be permitted. The proposed cost increases are about six per- 
centage points less than their rate of increase in 1975. If, in the 
absence of the proposed controls, these prices would continue to 
increase at the higher 1975 rates during fiscal 1977, then the price 
reductions due to this proposal alone would be worth $1.18 billion in 
fiscal 1977. The budget message argues that total Medicare costs 
would be lower by $2.2 billion as a result of the entire Medicare 
proposal. The remaining budget savings would be due to a predicted 
reduction in utilization rates. 

It is not clear whether this proposal would affect medical care 
costs in the rest of the economy since no controls are proposed for 
medical prices other than those to be reimbursed under Medicare. 

It should be noted that this proposal differs from others that have 
been mentioned in that it involves direct controls over private prices. 
The other proposals concern changes in prices and costs that are 
already publicly determined. 

Price controls on medical care were reasonably effective during the 
economic stabilization period of 1971 to 1974. Except for this period, 
hospital service costs have grown steadily relative to other prices for 
the last 20 years. The trend has been most evident since the enactment 
of Medicare and Medicaid in 1965. The table shows the abnormal 
behavior of prices in the medical care industry. 





1st half 1975 


4. 6 

6. 4 

7. 5 

Medical care 

6. 7 

4. 3 

12. 5 

Medical care services 

7. 6 

4. 9 

12. 8 

Semiprivate room 


5. 7 


Physician fees 

7. 4 


11. 6 

1 Economic stabilization period. 

9 Other minor increases included in the $700 million are the imposition of $80 
million of waterway user taxes and an increase in uranium prices that are 
charged to private utilities of $91 million. 


While medical price increases were suppressed during the stabiliza- 
tion periods, institutional changes which would promote price reduc- 
tion did not take root at that time. The measures employed by hos- 
pitals to restrain inflation were targeted toward short-term efficiencies 
such as restraining employee salary increases, and freezing staffing 
ratios, rather than to more rational control of long-term costs. The 
exceptionally large increase in medical prices in 1975 was, in part, a 
realization of cost increases that had been suppressed during the- 
economic stabilization period. 

It should be noted that non-Federal medical care costs would not 
fall, and could even be increased as a result of this proposal. This 
would happen if hospitals did not hold down costs and raised charges 
to non-Medicare patients by enough to cover the cost increases for all 
patients. If the prices charged to non-Medicare patients are not 
affected by this proposal, it would reduce the GNP deflator by 0.06 

Grants to States 

The reduction in grants to State and local government would have 
an uncertain effect on budget decisions in those jurisdictions. A part 
of the reduction could result in lower spending, and a part in higher 
taxes. If sales taxes, property taxes, or other excise taxes were in- 
creased, prices and costs would rise directty. The size of these tax 
increases has been estimated to be about one-third of the size of the 
reduction in general grants, and one-fourth the size of categorical 
grants. 3 Thus an $8 billion reduction in grants would cause these 
taxes to rise by about $2.0 billion and would cause the deflator to 
increase by about 0.11 percent. 

Total Inflationary Effect 

Each of the proposals described above represents a request by the 
Administration that may be subject to controversy in the Congress. 
The proposals involve changes from current policy budget levels, from 
established procedures, or from prevailing prices that are being charged 
by government enterprises. Factors other than inflation, such as pro- 
gram efficiency, will also have to be considered. 

The total direct effect on the GNP deflator of these proposals is 
estimated to be 0.68 percentage points as shown in Table 2. That is, 
this index would be higher by more than 0.68 percent if the inflationary 
option were chosen in every case than if the alternative were chosen. 
Since some of the Administration proposals would reduce prices, the 
net effect of the Administration's position would be to raise the deflator 
by about 0.14 percent, though the effect on private prices and costs 
could be more than twice that. These estimates are summarized in* 
the table below. 

It should be noted that the indirect effect on costs could also be 
substantial, though these estimates have been excluded from the 
table. Wage increases could moderate in the future, for example, if 
large price increases could be avoided in the shorter term. The Notes 

8 Edward M. Gramlich and Harvey Galper, "State and Local Fiscal Behavior 
and Federal Grant Policy." Brookings Papers on Economic Activity, 1973:1,. 
pp. 15-58. 

72-678—76 2 


to Table 2 below describe how the estimates were derived. Effects 
are shown for both the GNP deflator — which covers the entire economy 
including the government sector — and for the private sector alone. 



Effect on Effect on 

GNP private 

Item deflator costs 

Proposed increase in employee payroll taxes of 

$5,000,000,000 +0.26 +0.27 

Limit Federal pay increase to 5 percent —.19 

Increase in user taxes by $736,000,000 +.04 +.04 

Medical care price controls —.06 

Reduction in telephone excise tax (mandated in 

existing law) —.02 -.02 

Increase in State sales taxes that could result 

from a reduction in grants of $8,000,000,000___ +. 11 +. 11 

Potential inflationary impact of the President's 

proposals +.14 +.40 

Total difference between most inflationary and 

least inflationary options +.68 +.44 

Notes to Table 2 

The estimates of the direct effect of lower taxes and prices on the price level 
were calculated as follows. For the GNP deflator, the dollar values of the proposed 
changes were divided by the level of GNP that is expected for the period. The 
GNP estimates are those provided in the President's budget. The payroll tax 
proposal would be effective January 1, 1977. It was divided by $1,890 billion, the 
projected level of GNP for calendar 1977. Other proposals were calculated under 
the assumption that they became effective on October 1, 1976. A GNP of $1,839 
billion was used for these proposals, since that is the level of GNP projected for 
fiscal 1977. 

The effects on the private cost of living were estimated by adjusting the GNP 
estimates for two factors. (1) Compensation of Federal employees was subtracted 
leaving an adjusted GNP of $1,770 billion for fiscal 1977 and $1,823 billion for 
calendar 1977. (2) Those prices not paid by the private sector — such as Federal 
salaries — were not included in the private cost of living. 


The proposals discussed above include only those changes from 
current policies that have been specifically proposed by the President. 
A wide range of additional options exist if Federal policy were to 
deliberately seek out price-reducing measures. 

First, and most obvious, wherever an increase in prices ha*s been 
proposed, decreases are an alternative to be considered. Payroll taxes, 
for example, can be reduced rather than increased and prices would 
then be pushed down rather than up. 

Second, some additional budget proposals exist which could affect 
inflation but which do not involve direct controls over prices or costs. 
The President has proposed, for example, that $870 million worth of 
materials be sold from strategic military stockpiles. The sales would 
restrain increases in the prices of these materials by an undertermined 


Third, the budget also affects prices in many ways in areas where 
the President has not called for major changes. The list of changes 
above for which inflationary price tags have been estimated was 
selected because they require major budgetary decisions for fiscal 1977. 
The scheduled expiration of the telephone excise tax could be ac- 
celerated, for example. Interest subsidies for home buyers could be 
expanded. Subsidies could be increased for AmTrak or the Postal 
Service. Gasoline, tobacco, and alcohol taxes could be reduced. 

Fourth, new budget options could be proposed that are specifically 
designed to cause prices to fall. Grants could be given to State and local 
government in exchange for reductions in sales taxes. These programs 
could be voluntary, though it is unlikely that any State would turn 
down a chance to reduce its own citizen's taxes, particularly if it 
thought that the Federal grants would be permanent. A $10 billion 
program of this kind would lower the Consumer Price Index by a full 
percentage point in its first year. The more broadly based GNP 
deflator would fall by less. The Consumer Price Index also has a larger 
effect on private wage decisions than the GNP deflator, so that the 
feedback from such price cuts on future wage decisions could be 

Fifth, non-budgetary government programs can be used to change 
prices directly. The President has proposed that transportation 
regulations be changed so that shipping rates can fall. Natural gas 
and petroleum prices are determined in large part by the Federal 
Government. These prices have a substantial impact on the general 
price level. It has been estimated that the difference between the 
highest and lowest proposals for petroleum prices that were seriously 
considered in 1975 involved two full percentage points in the price 

Prices and Efficiency 

Prices serve an important purpose in guiding productive resources 
into those activities which are of greatest value in a free enterprise 
economy. The policy of direct cost reduction which has just been 
described would dull the effectiveness of the price system if the cuts 
were pushed too far, particularly if only a small number of products 
was involved. Prices fall when postal rates are cut, for example. But 
if postal rates are cut too far, the public would use the mail to a 
greater extent than they should. The Postal Service would then have 
to expand and the public benefits of the expansion would likely be 
less than the additional costs. Some feel that postal rates are already 
too low and that the subsidy should be ended. 

For this reason it is best to concentrate major cost reductions on 
those taxes which have a general impact on all products. Cuts in the 
sales or the payroll tax, for example, would not distort private alloca- 
tion decisions while lower postal rates might. 

A dilemma arises in cases like that of natural gas where a higher price 
is needed in order to have consumers economize on its use. If however, 
the higher price cannot be offset by cuts in other publicly controlled 
prices, and if the higher price cannot be accompanied by more fiscal 
and monetary stimulus, then a rejection of the price increase can be 
considered on the grounds that it will add to both inflation and un- 
employment. The inefficiency caused by having workers idle should be 


weighed against the inefficiency caused by having occasional shortages 
of natural gas. The impact on inflation of price increases of this kind 
is also an important criterion to consider. 

In this regard, one must question the overriding importance of 
having employers pay for the unemployment compensation system, 
or for the use of the payroll tax to finance the Social Security System. 
Grants from general revenue may violate the principles of the systems. 
But this effect must be weighed against the adverse effect on inflation 
and unemployment of the payroll taxes that support these systems; 

Long-Run Effect 

These price policies will reduce the price level directly and therefore 
will reduce the rate of inflation in the short-run. But the price cuts 
are "one-shot" and will have no direct effect on future inflation rates 
unless they are repeated. The long-run effect of this policy depends on 
its effect on wage rates. 

Historically, wage settlements have responded to changes in price 
inflation. If wage inflation were to moderate in response to the one-shot 
reduction in prices, then the long-run rate of inflation could be reduced. 
The lower wage inflation would reduce costs further leading to a 
further response of prices. The wage-price spiral would be partially 

Even with a beneficial response from wages, direct price cuts should 
not be viewed as an alternative to responsible monetary and fiscal 
policies, but as complementary to them. The direct price cuts provide 
an opportunity to reduce the inflation rate permanently without 
changing the rate of real economic growth. If monetary and fiscal 
policies were not trimmed accordingly when full employment was 
approached, the economy would soon revert to its original, higher rate 
of inflation. In this regard, the price cuts provide an opportunity to 
adjust from our present inflationary situation to a less inflationary 
one, but they cannot, by themselves make the less inflationary situa- 
tion permanent. 


The budget has a major direct influence on prices. The rate of infla- 
tion could be reduced by a point or more through moderate changes in 
prices and costs that are directly under the control of the government; 
New programs could be devised to spread the effect of the direct price 
reductions more broadly and to increase the size of the general impact 
on prices without seriously distorting other program objectives. The 
reduction in inflation would be temporary unless monetary and fiscal 
policies were adjusted to take advantage of the possibility that would, 
be created for a permanent reduction in inflation. 

Minority Addendum 

Fiscal policy and monetae policy interact with private 
sector demands to determine the total demand for goods and 
services, and the growth in that demand over time. The 
growth in demand, together with the recent history of wage 
and price increases, are the major determinants of the rate 
of inflation at any point in time. 


The growth in demand — as it affects prices and shapes the 
history of wage and price changes — becomes the dominant 
factor in determining the rate of inflation in the long run. The 
long run growth of demand is highly dependent on the rate of 
growth of the money supply. A major point of difference 
among economists is how quickly the current demand 
growth affects the rate of inflation. Some economists believe 
monetary and fiscal restraints on demand growth have more 
immediate effects on the rate of inflation. 

The Budget Committee strongly affects the growth of total 
demand by recommending overall fiscal policy and by in- 
fluencing monetary policy through fiscal policy and associated 
budget deficits. 

III. The Effect of the Budget on Inflation and Unemployment 

In this section, estimates of the impact of cost-cutting options on 
inflation and unemployment are discussed. The report concludes that 
reductions in directly controlled costs could reduce the unemploy- 
ment rate more than would an income tax cut of the same budgetary 
cost. The lower rate of cost inflation would be partially offset by a 
higher rate of demand inflation that would result from the larger 
economic expansion. But the estimates indicate that the net effect 
would be to reduce inflation and unemployment at the same time. The 
resulting level of unemployment and inflation would depend on many 
other factors, the most important of which may be monetary policy. 


No one has been able to forecast prices very accurately, particularly 
in recent years when special inflationary factors other than the level of 
economic activity have been of such major importance. Another world 
oil price rise could change the standard forecast by several percentage 
points. A bad harvest due to drought in the Southern Plans would have 
a visible, but smaller impact. Barring unforeseen special circumstances 
of this kind, the outlook is roughly as follows. 

Underlying Inflation 

Wage increases appear to be stabilizing in the 7 to 9 percent range. 
After remaining relatively constant for almost 5 years, wage-inflation 
increased when wage and price controls were eliminated in April 1974. 
From a previous rate of about 6 percent per year, wage increases rose 
at a rate of more than 12 percent in late 1974 and early 1975. The 
worst of that surge appears to be over and a new rate in the 7 to 9 per- 
cent range has taken hold for the last several months. This is the as- 
sessment given to the Budget Committee by Secretary of Labor Usery 
in his testimony of February 26, 1976. 

Wage increases in that range would normally be accompanied by 
price increases of about 6 to 7 percent. This appears to be the standard 
forecast for the next several years, and this report will use it as. a 
measure of underlying inflation. This forecast assumes that the re- 
covery will not be aborted by a low level of growth of the money supply. 


Demand Inflation 

With unemployment rates in the 7 percent range and with utiliza- 
tion of plant in the 80 percent range, there can be no inflation due to 
excess aggregate demand. The demand for output will remain below 
the Nation's ability to produce for the next several years. Most of the 
inflation that occurs in that period will be due to factors other than 
demand. Slack demand should allow the overall inflation rate to de- 
cline and the pace of that decline will depend on the level of demand. 

The Congressional Budget Office's (CBO) Five Year Budget Pro- 
jections describes two alternative growth paths: (A) a path which 
averages 5 percent real growth between now and 1981 and (B) a 6- 
percent path for the same period. No discussion of the policies needed 
to attain these paths is given. According to CBO, the rate of inflation 
should stabilize at about 6.6 percent per year along the fast path and 
gradually fall to 5 percent along the slow path. 

The purpose of the two CBO growth paths is to point out the effect 
of economic assumptions on the budget projections. No discussions of 
the monetary or fiscal policies needed to attain these alternative paths 
is given. It appears that money growth substantially above the upper 
range of current Federal Reserve targets would be needed to meet 
these paths in the next few years. Despite the limitations of the two 
paths, they do permit a reasonable assessment of the impact on infla- 
tion of a more rapid rate of economic growth. 

The inflation rate is higher along the fast path than it is on the slow 
path because resources are used more intensively. In particular, un- 
employment rates are lower and wage increases are higher along the 
fast path. This is due, in part, to the more rapid growth in the money 
supply that takes place along the fast growth path. The difference 
between the paths is displayed in the following table. 


Fast path (A) Slow path (B) 

Unemploy- Unemploy- 
ment Inflation ment Inflation 

1976 7.4 6.7 7.7 6.7 

1977 6.4 6.6 7.5 6.1 

1978 5.4 6.6 7.1 6.0 

1979 4.8 6.6 6.7 5.5 

1980 4 5 6. 6 6. 3 5. 

1981 4.5 6.6 5.9 5.0 

Average 5. 5 6. 7 6. 9 5. 7 

Between 1976 and 1981, the fast path would produce an unemploy- 
ment rate that averages 1.4 points lower and an inflation rate that 
averages 1 point higher than the slow path. Note that inflation continues 
to decline under both paths, but not as quickly on the fast path. The 
total difference between the two paths amounts to an incredible 
$1,078 billion of GNP over the 6 years. 


In short, the underlying inflation rate of 7 percent can be slowly 
reduced by gradually restraining demand, but with an enormous 
cost in terms of unemployment and production. The risk of an out- 
break of demand inflation is minimal when resources are under- 
utilized and growth rates are not excessive. Inflation does not 
accelerate even along the fast CBO growth path. Given the enormous 
cost of reducing demand inflation, it is important that all opportunities 
to reduce cost inflation be examined. 


The CBO provided estimates for this report that a permanent cut 
in the personal income tax of $10 billion would reduce the unemploy- 
ment rate by about 0.2 points within 2 years. The rate of inflation 
would be increased by less than 0.1 after 5 years as a result of the tax 
cut. These estimates are consistent with estimates published elsewhere 
by CBO. 1 

A rule of thumb that derives from this calculation is that for 
moderate changes in demand, the short-run effect on unemployment 
is about twice that on inflation. Every 0.2 percent that the unemploy- 
ment rate falls is associated in the long run with an increase in the 
inflation rate of 0.1 percent. This rule of thumb is a useful guide when 
unemployment rates are in the 7-8 percent range. As unemployment 
rates fall, the inflationary impact will be larger than this rvle suggests. 

It should not be assumed from this estimate that inflation must 
increase if income taxes are cut. The 0.1 percent of inflation that 
would result from the income tax cut represents a change from what 
would otherwise take place. If inflation rates would otherwise fall by 
0.5 percent, they would still fall with the enactment of a 10-billion- 
dollar income tax cut, but only by 0.4 percent. Similarly, the reduction 
in the unemployment rate of 0.2 percent is in addition to the reduction 
that would take place without the cut. 

The rule of thumb relating change in inflation to changes in unem- 
ployment permits us to calculate the cost of reducing inflation by 
restricting demand. At current levels of unemployment, an increase 
in the unemployment rate of 0.2 percent would be associated with a 
reduction in real GNP of about $9 billion. This would be associated 
with a reduction in the inflation rate of 0.1 percentage points. If this 
rule of thumb is valid for somewhat larger variations in demand, then 
the cost of reducing inflation by one full percentage point by restrain- 
ing demand growth is 2 percent in unemployment and $90 billion in 
output. Cost reductions have a much smaller price tag as is shown 

Longer-run benefits associated with a slower rate of inflation are • 
difficult to quantify. They include the greater likelihood that restric- 
tive policies which could induce recession will not be forthcoming at 
a later date. 

1 See Congressional Budget Office, Recovery: How Far and How Fast? Congress 
of the United States, September 1975. 




A reduction in the employer payroll tax would stimulate demand 
just as a reduction in the income tax would. This would tend to cause 
prices to rise. But the payroll tax is also a part of costs, and when 
costs fall, prices tend to fall as well. Which of these two effects is 
larger? That question is considered in this section. 

The many different costs that could be cut directly by government 
would have very different impacts on inflation and unemployment. 
Their direct inflationary effect was described in Table 2. Their indirect 
effect depends on several other factors. (1) It depends on the speed 
with which firms pass through their cost changes to consumers. (2) It 
depends on whether changes in final prices get magnified by having 
an effect on future wage decisions. (3) It depends on the amount of 
funds that are transferred from the public to the private sector in 
order to bring about the reduction in costs. The different programs 
described above could differ in these three ways, and some of the 
differences are hard to predict. The effect of the cost reductions on 
unemployment will also vary with the same three factors. 

The last factor is the easiest to identify. A transfer of funds from the 
public to the private sector has an effect on demand inflation and 
unemployment that is easily separated from the effect that derives 
directly from the price reductions listed in Table 2. 

A payroll tax cut would provide funds to the private sector. So 
would an increase in the Postal subsidy, the mass transit subsidy, or 
a reduction in sales or excise taxes. The reduction in private prices 
that are regulated by the government, such as the trucking transport 
costs or natural gas prices, would not transfer any funds to the private 
sector. And the price controls on Medicare reimbursements and the 
wage controls on Federal employees would reduce the funds that are 
transferred to the private sector. The effects of the cost reductions on 
demand inflation vary directly with the amount of funds being trans- 
ferred, and are about the same per dollar as the effects described above 
for the transfer of funds through a reduction in the income tax. That 
is, the aggregate demand pressure will be about the same whether the 
funds are transferred by reducing taxes or reducing prices. In some 
programs — such as the proposal to control Medicare costs — it should 
be noted that demand inflation and cost inflation are reduced at the 
same time. 

CBO was asked to perform three different calculations to determine 
the effects on unemployment and inflation of different kinds of cost 
reductions (1) The effect of a payroll tax reduction was estimated 
under the assumption that a change in the employer tax would affect 
final prices as fast as would any other change in labor costs, (2) the 
effect of a direct reduction in consumer sales taxes was estimated 
under the assumption that this would have no subsequent impact on 
wage decisions; and (3), the same calculation was performed as in (2) 
except that it was assumed that future wage inflation would respond 
to the direct reduction in prices the way it has historically. All calcula- 
tions were performed for a hypothetical $10 billion program. The 
effects for smaller programs can be estimated by reducing these 
figures proportionally. 


The effects of these hypothetical changes are summarized in Table 3. 
One striking result from the table is the power of cost reduction as an 
economic stimulus. Cost reduction would stimulate the economy in 
two ways. It would increase the number of dollars transferred from 
the government to the private sector by the same amount as the 
income tax cut. But since it would also lower prices, the purchasing 
power of all private incomes and assets would be increased. The 
impact of this second effect on unemployment would be quite powerful, 
according to the estimates provided. Direct price cuts are a powerful 
way to stimulate the economy and when unemployment rates are 
high, the price cuts are not offset in all cases by higher prices that 
result from the higher level of economic activity that takes place. 


Effect on 
ment Effect on price level 
rate in 

2d year 

1st year 

5th year 

(1) $10,000,000,000 cut in personal in- 

come tax_ 

(2) $10,000,000,000 cut in employer pay- 

roll tax _ 

-0. 2 
-. 4 


-. 2 

Percent 1 
+ 0. 5 

(3) $10,000,000,000 cut in consumer 

prices with no effect on future wage 

(4) $10,000,000,000 cut in consumer 

prices with normal effect on future 
wage inflation 

-. 5 
-. 6 


+ .2 

1 The figure reported in col. 3 is the estimated cumulative effect on prices over 
5 years. It is not the estimated rate of inflation in the 5th year, but the sum of the 
inflation rates for the 5-year period. 

Reductions in payroll taxes would work with a lag, but their final 
impact would be substantial. CBO estimates that 43 percent of a re- 
duction in employer payroll taxes would be reflected in lower prices in 
the first year and 47 percent in the second year. After 5 years, this 
initial price reduction would be just offset by the inflationary effect of 
the expansion. Unemployment would fall by almost twice as much 
under this plan as it would if ordinary income taxes had been cut, 
however, The unemployment rate would be 0.4 lower after 2 years, 
compared to a reduction of 0.2 that would result from the $10 billion 
income tax cut. The strong possibility that cuts in employer payroll 
taxes could reduce unemployment twice as much as an equivalent cut 
in income taxes with the same effect on prices makes payroll tax cuts a 
policy worth serious study. 

The numbers in Table 3 come from a model of inflation; a process 
that is not well understood. Therefore, the estimates must be evaluated 
with caution. Estimates of changes in inflation resulting from changes 
in policy, however, are more likely to be correct than estimates of the 
level of inflation (the level depending on other factors such as food 
harvests and OPEC oil prices.) 


Inflation and Unemployment 

Direct cost reduction was shown to be a powerful stimulus. Because 
of this, it would be dangerous to use this policy when unemployment 
rates were already low. Since the price cuts are a powerful stimulus, 
they would create shortages if the economy were already at full em- 
ployment. For this reason, the policy of cost reduction has not re- 
ceived much attention before. It would have been inappropriate to 
apply this policy to previous postwar inflations. It is the unique 
nature of the present inflation that makes this policy appropriate 

The policy has been used before, however, Recently, France cut its 
value added tax in an attempt to reduce inflation without increasing 
unemployment. The United States does not have a similar Federal 
tax that could be cut at this time. 

Most Federal excise taxes have already been eliminated. Many were 
reduced in 1965 in an effort to curb inflation. The others were reduced 
during the first term of the Nixon Administration for the same purpose. 
The economy was much closer to full employment in those years and 
thus the policy was less appropriate for reducing the inflation that was 
taking place then than it would be today. 


Reductions in prices and costs controlled by the government offer a 
promising opportunity to reduce the unemployment rate without in- 
creasing the inflation rate. Most other sources of growth, whether 
public or private, would lead to more inflation than if the growth were 
stimulated by direct cost reduction by government. The only other 
source of growth that would have the same beneficial effect on in- 
flation would come from price cuts in other economic sectors. If bounti- 
ful harvests caused food prices to fall or if problems within OPEC 
caused petroleum prices to fall, the economy would be stimulated and 
prices could fall at the same time. But with these special factors beyond 
government control, direct reductions in costs by government should 
be considered. 

Through moderate changes in a variety of prices and costs that are di- 
rectly controlled by the Federal Government, the inflation rate and the un- 
employment rate can be reduced at the same time. These constrictions 
must be balanced in the long run by reductions in the levels of mone- 
tary and fiscal stimuli if the reduction in inflation is to be maintained. 
The 1977 budget deliberations present an important opportunity to 
begin a policy of this kind. 



The simultaneous existence of inflation and unemployment makes 
the economic problem of the last few years a unique post-war experi- 
ence. It was argued above that this unique situation calls for a policy 
of cost reduction on the part of government since such a policy can 


attack inflation and unemployment at the same time. In order to 
gain perspective on the present policy dilemma, the history of the 
recent inflation will be discussed here. 
The data to be presented show that — 

(a) the inflation was started in a few special sectors; 

(6) it eventually spread to other sectors of the economy; and 

(c) that as a result, the underlying rate of inflation is now quite 

high by historical standards. 
It is always difficult to separate cause from effect when interpreting 
economic history. One plausible interpretation of the data is that the 
inflation was caused by a group of special factors that increased prices 
and costs in the sectors in question, and that it was not caused by an 
excessively stimulated economy. The increase in costs tended to drain 
purchasing power from the economy so that unemployment rose with 
the inflation rather than declining as it would if the inflation were 
due to too much demand. 

While this interpretation is consistent with the data, it should 
be noted that price controls were in effect through much of the period, 
and that they provide an important qualification to any conclusions 
that are drawn. This problem is discussed further below. 


The data presented in Table 4 break down the inflation into several 
components — food, energy, imports, and mortgage interest costs — for 
each 6-month interval since late 1972. Inflation seemed to be under 
control in late 1972. Over the last 6 months of that year, the Con- 
sumer Price Index (CPI) increased at a rate of 3.71 percent per year. 
That was about two points lower than its level of 3 years before. The 
inflation was distributed relatively evenly over the various components 
of the index. Price controls were in effect and seemed to be working. 
The goal of the controls was to get the inflation rate below 3 percent 
and, for a few months in late 1972, this was accomplished. 

The trouble began in early 1973, when prices of uncontrolled food 
and energy products began to increase at double-digit rates. While 
the rest of the economy did not experience this inflation, the average 
price level including food and energy rose at a rate of 8.2 percent as 
measured by the CPI. Within that average, the food component 
rose at a rate of 23.1 percent and the energy components rose at a 
rate of 11.4 percent. All other factors together rose at a rate below 
4.3 percent. 

In late 1973, the divergence among product prices was even more 
pronounced. The four special factors that are considered in this 
section — food, energy, mortgage interest costs, and imports — were 
responsible for more than 80 percent of the inflation during the last 
6 months of that year despite the fact that they comprise only 40 
percent of the index. Food prices went up at a 17-percent rate, energy 
prices at a 22-percent rate, mortgage interest costs at a 40-percent 
rate, and imports other than food and fuel at a 20-percent rate. All 
other prices — about 60 percent of the total index — increased at less 
than 4.5 percent. Despite the lack of a pervasive inflation, the CPI 
increased at a rate of 9.43 percent. 




July- Jan.- July- 
Dec. June Dec. 
1972 1973 1973 

Jan.- July- Jan.- 
June Dec. June 
1974 1974 1975 

CPI inflation 



8. 2 







6. 8 

CPI food 



23. 1 







5. 6 

CPI energv 



11. 4 






13. 3 

CPI mortgage interests. __ 



-1. 5 







1. 9 

Imports 1 

■ 3. 









9. 9 

Residual J 







7. 3 


Food 29. 6 61. 4 

Energy 9. 3 8. 2 

Mortgage interest 7. 3 —.7 

ai:::::::::::::-^ ^ 

Total CPI inflation. 100. 100. 

42. 8 

24. 3 

25. 1 

20. 5 


20. 7 

2. 2 

13. 4 

14. 2 

4. 2 

9. 9 

1. 2 

9. 1 

8. 1 


6. 3 

19. 9 

42. 7 

52. 8 

58. 6 




100. o- 


Food 0. 24785 

Energy . 06964 

Mortgage interest . 04385 

Imports . 04448 

Residual .59418 

Total 1. 00000 


(a) The weights in Part III of the Table for food, energy, and mortgage interest 
costs reflect the relative importance of these sectors in the Consumer Price Index 
in December 1974 as reported by BLS. These weights change over time as infla- 
tion proceeds unevenly, and the figures in sections I and II reflect these changes. 

(b) The energy index is the weighted sum of the separate CPI components for 
gasoline and motor oil, fuel oil and coal, and gas and electricity. 

(c) The mortgage interest cost index is derived as the difference between the 
special CPI index excluding mortgage interest and the entire CPI, using the ap- 
propriate weights. 

(d) The index for imports less food and fuel is derived from Table D of the 
September 1975 Survey of Current Business (p. 44). No separate import component 
appears in the CPI, so this index which depends on balance of payments data is 
used. Its weight of 0.04448 is the average ratio of non-food, non-fuel imports to 
GNP over this period. The weight is not varied over the different time periods in 
the table above. 

The import index is not available for 1972, so there is no import index reported 
for the first two time periods in the table. 

(e) The selection of data presented in the table represents one of many ways to 
separate the inflation rate into its various components. Another way is to use the 
GNP deflators. In principle, this would give a more accurate indication of the 
sources of inflation, but even the GNP data are not collected in such a way as to 
make the division a simple one. 

The problem with the CPI is that the final components contain many inter- 
mediate products. The CPI for food, for example, measures retail food prices. But 
these prices include large costs for packaging, processing, and transportation. 


There is a lot more than farm output in the CPI food index, and there is some rea- 
son to believe that these other factors were responsible for part of the recent in- 
crease in food prices. 

On the other hand, energy is an input into most forms of production, so that 
much of the inflation that is reported in the table as taking place in the residual 
industries is really due to higher energy costs. Similarly, interest costs are much 
more important than indicated in the table since the table only measures mortgage 
interest costs. 

In total, the special factors isloated in the table represent some over and under 
estimates of the importance of those factors. Other studies which use other data 
confirm the general pattern of the inflation described in the table. 

In each of the highly inflationary sectors, special circumstances 
caused shortages of the commodities in question. Bad harvests world- 
wide and the emergency of Japan as a major world food customer 
greatly increased the demand for American food. The oil embargo cut- 
off a major U.S. source of petroleum and environmental restrictions 
caused low sulfer coal to sell at a premium. Import prices soared, 
particularly raw materials prices, as worldwide demand expanded at an 
unusually high rate. This was due partly to the growing importance of 
Japan as a raw materials customer and partly to the rare phenomenon 
of a simultaneous boom in all industrialized economies. There were also 
devaluations of the dollar which were responses to historical trends in 
costs and interest rates in the United States and abroad. Interest costs 
increased as the Federal Reserve attempted to halt the inflation by 
tightening the money supply. 

These special circumstances were responsible for beginning the in- 
flation the United States now experiences. Price increases were caused 
only in part by excess demand for output in the United States; excess 
demand worldwide contributed heavily to the pressure on prices. This 
combination of events would have caused an acceleration in the rate of 
inflation in the United States even if domestic demand had been re- 
stricted by monetary and fiscal policies. Even if these policies had 
restricted demand sufficiently to increase the rate of unemployment to 
6 percent, rather than the 5 percent rate that prevailed, the special 
problem that caused food and fuel prices to rise would have increased 
the general price level. The size of the total increase would, however, 
have been somewhat smaller. 

In 1974, the inflation rate began to spread from food, energy, im- 
ports, and mortgage interest rates to other sectors of the economy. 
Price controls were eliminated in April and wages started up. In the 
first 6 months of 1974, the CPI increased at a rate of 12.5 percent. The 
special factors still were causing an abnormal share of this inflation — 
particularly energy prices which increased at a rate of 43 percent — but 
the prices of the 60 percent of the index which had been stable until 
1974 increased at a rate of 11.6 percent in the first 6 months of that 
year. The inflation which began in special, isolated sectors had begun 
to spread to the rest of the economy. By the last half of 1974, infla- 
tionary pressures were widespread. In the four special sectors, the 
inflation rate had fallen below 14 percent, while in the rest of the 
economy it was near 10 percent. 

In the first half of 1975, the special factors had a lower rate of infla- 
tion than the rest of the economy. The total CPI increased at a rate of 
only 6.8 percent despite an inflation rate of 7.3 percent in all sectors 
except the four special ones. The data for all periods are presented in 
the table. 



The extremely unbalanced nature of the inflation, particularly in its 
early stages, supports the conclusion that the inflation was due pri- 
marily to a few special factors. Inflation caused by excess economic 
activity tends to proceed in a much more balanced way across the 
whole range of goods and services. While the existence of price controls 
may have distorted normal relationships, there simply was no serious 
inflation in 1973 except in those sectors which had special problems. 

Further evidence that the inflation was not due to excess aggregate 
demand is found in the relation between inflation and the level of 
utilization of capacity of the economy. 

The following chart presents the history of inflation and unemploy- 
ment since 1954. Note that until 1973, the unemployment rate and the 
inflation rate generally moved in opposite directions. Over that period, 










/ \ y 

/ N 

/ V 


# • • 

i i i i i i r I I 

56 58 60 62 64 66 63 70 72 74- 


Inflation — 12 month moving average of CPI. 

Unemployment --12 month moving average of the unemployment rate. 


one could make reasonably good predictions of how the inflation rate 
would change simply by noting the unemployment rate. When the 
unemployment rate was below the 4.5 to 5 percent range, inflation 
accelerated; when it was above that range, inflation fell. 

This data supports the conclusion that in the 2 decades before late 
1973, inflation was caused by excess demand. When the economy 
expanded, the unemployment rate fell and the inflation rate increased. 
Since late 1973, a different relationship has emerged. Inflation appeared 
when the unemployment rate was not excessively low, and it continued 
to accelerate even when unemployment was quite high. Instead of 
excess purchasing power driving prices up, in the recent period the 
higher prices have reduced real purchasing power and forced cutbacks 
in production. 

The price controls of 1973-74 offer an alternative explanation of the 
unbalanced nature of the inflation, since it was worst in those sectors 
which were uncontrolled. But if the inflation had been due to excess 
demand, one would have expected the unemployment rate to fall when 
the inflation rate increased. The fact that since mid-1973 they both 
increased at the same time supports the conclusion that the increased 
rate of inflation since that time has been due to cost factors rather 
than to demand. 

Summary to Appendix 

Just as these higher prices caused production to fall, lower prices 
brought about by direct government action can cause production to 
increase. While there remains a tradeoff between inflation and unem- 
ployment, in the sense that general economic activity affects them in 
opposite directions, policies are available which can reduce both of 
these evils at the same time. 

The unbalanced nature of the recent inflation suggests that it was 
caused by special cost factors rather than by excess demand. This 
conclusion is also supported by the fact that this inflation was ac- 
companied by high rather than low unemployment rates. Since reduc- 
tion in those prices that are directly controlled by government should 
have the opposite effect on the economy to that caused by the OPEC 
price increase, it should be expected that prices and unemployment can 
be reduced at the same time through a policy of direct reductions in 



This paper was prepared to provide background for the deliberations 
of the Senate Budget Committee prior to their markup of the First 
Concurrent Resolution on the Budget for Fiscal Year 1977. 

The report was prepared by Arnold Packer, Anthony Carnevale,. 
Charles McQuillen, and Martin Asher of the Senate Budget Committee 
staff and by David Mundel and Alan Fein of the Congressional 
Budget Office. 

Edmund S. Muskie, 

Chairman . 



I. The Problem and Alternative Solutions 


1976 and 1977 

More Americans either lost or failed to find opportunities to earn 
livings commensurate with their ability in 1975 than in any other year 
since the depression of the 1930's. 

In the first quarter of the bicentennial year 7.6 percent of the form- 
ally defined labor force was unemployed, about 7.2 million individuals. 
Another 0.9 million people has dropped out of the formal labor force 
because they failed to find work and gave up the search. Although 
there has been substantial improvement since the 8.9 percent unem- 
ployment recorded last spring, the unemployment at the end of this 
year will still exceed that recorded in the depth of previous post-war 

The unemployment rate for this year will be determined by the 
fiscal and monetary policy set for fiscal 1976 and the Transition Quarter. 
Most forecasters believe that these policies will bring unemployment 
down by [one-half percentage point more (to 7.0 percent) during the 
course of this year. Most forecasters also predict that the unemploy- 
ment rate will decline moderately again during fiscal 1977 if Federal 
expenditures and revenues are maintained at the current policy level. 

The Longer-Term Future 

Under any credible set of economic assumptions, unemployment 
will be at unusually high levels for at least several years beyond 1977. 

The Congressional Budget Office (CBO) has developed two economic 
paths upon which to base a 5-year budget projection. 1 The "slow- 
growth" path is more optimistic than some private forecasts and 
provides for sustained growth rates that equal the best of the postwar 
years. The "fast-growth" path probably comes olose to the best that 
could be achieved under the most favorable conditions. The number 
unemployed under these two outcomes are shown below : 


[In millions] 

CBO path 1975 1976 1977 1978 1979 1980 

Number unemployed: 

Slow growth (path B) 7. 7 7. 2 7. 2 7. 6. 7 6. 4 

Fast growth (path A) 7. 7 7. 6. 2 5. 4 4. 9 4. 7 

Number employed: 

Slow growth (path B) 84. 8 87. 89. 2 91. 7 94. 96. 2 

Fast growth (path A) 84. 8 87. 3 90. 6 93. 8 96. 6 99. O 

1 See Five-Year Projections Fiscal Years 1977-81, Congressional Budget Office, 
January 26, 1976. 




The ideal solution to the unemployment problem is to create an 
economic climate in which all Americans of working age can realize 
their full potential without creating inflationary labor shortages. Given 
the present state of the economy, this ideal solution cannot be fully 
achieved. A more realistic set of goals would be to — 

(1) provide most individuals with an opportunity to use their skills 

in a manner that would provide adequate incomes and reason- 
able job satisfaction without creating inflationary labor 

shortages ; 

(2) establish education and training programs that could develop 

and maintain the skills required in the labor market-: 

(3) enforce anti-discrimination laws and improve information and 

placement services so that there is a better match between 
available opportunities and available human resources; and 

(4) provide, without reducing the incentive to seek employment, 

adequate income maintenance so that those who cannot find 
appropriate employment still can maintain an adequate 
standard of living. 

It is difficult to translate these broad goals into specific numerical 
unemployment rate targets. Most observers believe that an unem- 
ployment rate of 4.0 to 5.5 percent would satisfy the first goal, given 
the current labor market structure. However, even the high 5.5 percent 
unemployment rate probably cannot be achieved before 1978 and may 
not be achieved b}^ 1981 if the slow growth path is chosen. Therefore, 
a fifth goal must be added for the next few years, to be achieved by — 

(5) structuring Federal budgets in a way that will provide the 

appropriate response to the abnormally high unemployment 
that appears inevitable while enhancing the possibility of 
meeting the first four goals as the economy is restored to full 


A diversity of approaches to alleviate unemployment undoubtedly 
will be used during the next 5 years. The basic policy question is not 
which approach to use but rather what mix provides the best overall 


The most important approach, and the one without which no 
approach can succeed in the long run, is to set general fiscal and 
monetary policies that will increase economic demand in the private 

sector. The Budget Committee must recommend overall spending and 
revenue targets to the full Senate on April 15. The Committee should also 
indicate its economic goals and expectations to the Federal Reserve Board. 


Training, education, placement services, day care programs, and 
other programs to improve the match between skills and opportunities 
will be important elements of the solution. Other experimental ap- 
proaches such as wage subsidies might be considered. The Committee 
must indicate its view on the President 's proposed accelerated depreciation 
on investment in high unemployment areas. 



Unemployment compensation, food stamps, welfare assistance, and 
other similar programs can help maintain adequate standards of living 
on a temporary basis for the unemployed. The Committee must decide 
whether to recommend extension oj the Federal Supplemental Benefits 
(FSB) and Special Unemployment Assistance (SUA). 


Anticyclical revenue sharing, federally financed public works pro- 
jects, and/or other public employment programs can directly increase 
the number of available jobs in the United States. The Committee must 
decide whether to include funds for these programs in the First Concurrent 
Resolution (FCR) . 

Not only are all four of these approaches probabty necessary, they 
must be integrated as part of a total national effort. Funds spent for 
public works, training, or income maintenance not only provide direct 
assistance to individuals, they provide additional fiscal stimulus for 
the economy as a whole unless their effect is offset by tax increases or 
reductions in spending for other purposes. The Committee must also 
bear in mind the inflationary risk of an overly stimulative budget and 
the potential that inflation may have for thwarting the economic 

II. Growth: How Fast? 


The most important decision Congress must make about unem- 
ployment is whether to adopt fiscal and monetae policies that will 
produce fast growth of the economy over the next 5 years. 

Restoring a healthy economy clearly is the most desirable way to 
solve the unemployment problem. The most durable and socially 
acceptable employment is generated either in response to consumer 
demand for goods and services or to citizen demand for public services 
which the citizens are willing to support with tax dollars. These 
positions, derived from economic demand, offer the best chance for 
entry into career ladders leading to permanent jobs at adequate pay. 

The two economic growth paths charted by the CBO would produce 
very different employment outcomes as shown in Table 1. 

The CBO slow growth path would leave 1.6 million more unem- 
ployed in 1978 or 6.3 million more person-years of unemphr^ment 
over the 1976-80 period than would the fast growth path. Counting 
discouraged workers makes the difference even more dramatic. The 
difference in the number employed would, be 2.1 million in 1978 or 9.2 
million person-years of employment over the 5-year period. Moreover, 
even this understates the difference in employment experience. Fast 
growth undoubted^ would produce higher productivity and larger 
real wage gains. Promotion, advancement, and other signs of career 
advancement would be more prevalent with fast growth as would 
profits and business investments. 

The major danger of faster growth is that it could be more inflation- 
ary. Many (but not all) econometric studies indicate that inflation 
depends on how low unemployment gets, not how fast it get9 there. 


If this is correct, inflation would be the same after unemployment 
falls to 4.5 percent whether this goal were achieved in 1980 or 1985. 
The price level would be, however, higher under the faster growth 
path because inflation would be higher in earlier years. Moreover, 
the possibility that there are "speed limits", beyond which inflation 
accelerates independently of the level of unemployment, cannot be 
ignored. The CBO annual report contains a discussion of the alterna- 
tive paths, the fiscal and monetary stimulus required for each, and 
the inflationary risks. 

Unemployment: The Many Problems 

The United States has not just one unemployment problem but 
many. And the right mix of solutions to unemployment depends 
upon who is unemployed, and why. 

Younger workers, for example, have relatively high unemployment 
rates even when jobs are plentiful and suffer disproportionately from 
recession-induced unemployment. 1 Although workers between the 
ages of 16 and 24 account for only about 20 percent of the civilian 
labor force, they accounted for about 48 percent of the recession- 
induced unemployment between 1973 and 1974. As shown in Table 2, 
fast growth would provide 400 thousand more jobs for teenagers in 
1978 than would a slow growth path. 

Figure 1. — Distribution of the civilian labor force and recession-induced 
unemplo3'ment among age groups 

Source : U.S. Department of Labor, Bureau of Labor Statistics. 

1 Recession-induced unemployment is calculated by subtracting the unemploy- 
ment during periods of low overall unemployment from that during periods of 
high overall unemployment. 


Nonwhite workers of all sexes and all ages have higher unemploy- 
ment rates than do their white counterparts during periods of both 
low and high unemployment. When the recent recession began, the 
unemployment rate among nonwhite workers was 4.3 percentage 
points higher than that among white workers. It was 6.0 percentage 
points higher at the depth of the recession and 6.2 in the first quarter 
of 1976, as shown in Table 3. Fast growth would mean 350,000 more 
jobs for minorities in 1978 (Table 2). 

There is a direct correlation between levels of education and un- 
employment. In March 1975, the unemployment rate for college 
graduates was 2.9 percent while the rate for workers who had not 
graduated from high school was 13.8 percent. The rate for all workers 
was 9.2 percent. 3 Less educated workers also account for dispropor- 
tionately high shares of recession-induced unemployment. Workers in 
manufacturing (for both durable and nondurable goods) and construc- 
tion account for disproportionately high shares of recession-induced 
unemployment. 4 


[Thousands of persons] 

1976 1977 1978 1979 1980 


Males : 

(16-19) : 

Nonwhite 10. 

White 28. 3 

(20-24) : 

Nonwhite 10 

White 50 

(25-59) : 

Nonwhite., 13. 8 

White 96. 2 

(60 and over) : 



Females : 


Nonwhite 6 

White 27 

(20-24) : 

Nonwhite 3 

White 29 

(25-59) : 

Nonwhite 7 

White 79. 

(60 and over) : 

Nonwhite — , 

White -4. 


1, 303 

2, 113 

2, 592 

2, 809 

10. 7 
28. 3 

35. 8 
97. 9 

52. 1 
153. 8 

178. 3 

51. 7 

10. 7 

36. 3 
183. 2 

51. 4 

282. 1 

54. 8 
314. 9 

51. 8 

13. 8 
96. 2 

62. 2 

115. 2 

150. 2 
524. 8 

170. 1 
528. 4 

1. 7 
-6. 4 

5. 4 

-29. 6 



14. 1 



26. 4 

4.3. 4 

56. 3 

60. 7 


95. 8 

153. 7 

182. 9 

187. 3 

16. 7 

31. 8 


26. 7 


102. 6 

143. 7 

141. 8 

116. 4 

34. 5 

72. 8 

106. 9 

132. 4 



693. 4 

859. 9 

904. 9 


-3. 7 



-10. 5 


-63. 9 

-120. 6 

-76. 9 

22. 6 

1 From unpublished Urban Institute data. 

* Monthly Labor Review, February 1976. Not seasonally adjusted. 
4 Derived from Manpower Report of the President, April 1975. 




Unemployment rate 

1973 :IV 

1 Q7c: -TT 

1 Q7A -T 

iy /o.i 




8. 7 

7. 6 

Adult males _ __ ____ — _ 



7. U 

5. 7 




6. 4 

5. 1 

Nonwhite 2 _ . _ _ 



11. 8 

10. 9 

Gap (nonwhite-white) 



5. 4 

5. 8 

Adult females. _ _ 



O A 

1 A 

7. 4 




7. 9 

6. 8 

Nonwhite 2 _ __ 



11. 9 

11. 1 

Gap (nonwhite-white) 




4. 3 

Teenagers (16-19) __ 



10. 1 

19. 4 

White __ 



18. 1 

17. 5 

Nonwhite 2 _ _ _ 



37. 2 

35. 2 

Gap (nonwhite-white) 



19. 1 

17. 7 

All white 



8. 1 

6. 9 

All nonwhite 



14. 1 

13. 1 

Gap (nonwhite-white) 




6. 2 

1 Seasonally adjusted quarterly rates: U.S. Department of Labor, Bureau of 
Labor Statistics. 

2 Negro and other races of whom 89 percent are Negro. See Employment and 
Earnings: October 1975, U.S. Department of Labor, Bureau of Labor Statistics, 
p. 161. 

Unemployment among household heads has increased dramatically 
during the current recession. In January 1974, 1,533,000 household 
heads were unemployed. By November 1975, this number had grown 
to 2,980,000. Over a similar time period, the unemployment rate for 
household heads increased from 2.9 to 5.6 percent. 5 (See Figures 2 
and 3). 

As to the why of unemployment, it can be caused by a number of 
factors, including — 

— cyclical inadequacies of demand that cause short-term layoffs 
or furloughs; 

— lags between the time workers leave one job and the time they 
find others; 

— structural imbalances between the skill levels of available workers 

and the skill requirements of employers ; 
— disparities between the geographic locations of jobs and the 

homes of workers; and 
— seasonal imbalances between numbers of jobs and numbers of 


Taking the who and why of unemployment together, it can be seen 
that not only does the unemployment rate vary among population 
groups, its causes vary among groups. The chronically high unem- 
ployment rates of teenagers is due in part to their lack of job skills 
and work experience, in part to the limited attractiveness and con- 

a Unpublished Bureau of Labor Statistics data; 


Figure 2. — Unemployment rates of household heads 
(seasonally adjusted) 1 

i 1 i 

i J 

j l 

j I 




— - 





. — 


• - 

— ■ 

— ... 

" " i 



1 I 






Jan. June Jan. June r>c 

1974 1974 1975 1975 197S 

1 Unpublished BLS statistics. 

Figure 3. — Number of unemployed household heads 
(seasonally adjusted) 


■tPLOYLb iipua 


' ; 


- — j 

i — 

, — 



1 — ' 







Jan. June Jan. June Dec. 

1974 1974 1975 1975 1975 

Source : BLS unpublished statistics. 


stancy of the jobs to which they have access, and in part to their more 
limited need for income. The higher unemployment rates of less- 
educated workers is associated with their disproportionate employ- 
ment in industries with high employment variability. Even when 
workers with lower levels of education are within stable industries, 
they are more likely to be subject to unemployment than better 
educated workers. Workers in manufacturing and construction are 
more vulnerable to cyclically induced unemployment than most 
workers because of the cyclical volatility of demand for their industries' 

The uneven incidence of structural and cyclical unemployment and 
the variety of economic and social factors that cause unemployment 
create a need for a wide range of short- and long-term direct Federal 
responses to particular unemployment problems. One specific response 
must be directed to the training and experience needs of teenagers, 
another to the income maintenance requirements of families, and a 
third to prevent the social damage that arises from long-term unem- 
ployment of primary family worker*. 

III. The "Direct Response 1 ' of the Federal Budget to Unemployment 


All Federal expenditure and revenue policies affect the levels of 
employment and unemployment. Defense and nondefense purchases 
of goods and services result in jobs. And as long as there are unemployed 
resources, these jobs result, in turn, in more jobs through the effects 
of the fiscal multiplier. Income assistance programs increase consumer 
expenditures and this produces increases in employment. In a similar 
manner, tax decreases and increases influence consumer and corporate 
expenditures which affect the level of employment. The potency of 
the fiscal stimulus depends, of course, on the amount of slack in the 
economy and the degree of monetary accommodation. 

Table 4 categorizes various Federal programs according to whether 
they actually create employment opportunities, increase the employ- 
ability of workers by increasing skills and facilitating access to the 
job market, or provide income assistance to unemployed individuals. 
Each set of programs represents a distinct response to employment 
conditions. In the aggregate these programs (and overall fiscal policy) 
represent Federal employment policy. 

For fiscal 1977, the current policy estimate for this programatic 
response to unemployment is $41.7 billion in outlays and $4.9 billion 
in tax expenditures. Approximately J+S percent of current policy outlays 
finance programs that improve employability; and J}5 percent to programs 
that provide assistance to the unemployed and 12 percent to projects that 
increase employment. 1 (see Table 5 and Figure 4.). 

The programs included in Table 4 vary considerably in their re- 
sponsiveness to the business cycle. Most programs that create employ- 
ment directly are the result of increases in unemployment. For ex- 

1 The allocation is based on a very broad definition of programs that increase 
employability; it includes Federal aid to elementary, secondary, and higher 
education (excluding research and general education aid) as well as manpower 
training and vocational rehabilitation. 


ample, the Congress passed temporary stimulus measures such as 
Temporary Employment Assistance, Counterc3^clical Revenue Shar- 
ing, and Accelerated Public Works. Virtually all programs that are 
intended to improve employability are less sensitive to changes in 
employment. Spending for programs in the third category, those 
that provide income for the unemployed, vary directly with changes 
in employment. 

The cost of employment-related programs will vary over the next 5 
years according to the speed with which the economy recovers from 
the current recession. Tables 6 and 7 below demonstrate the impact on 
costs in the unemployment budget under "slow" and "fast" recovery 
assumptions. 2 As a comparison of the two tables demonstrates there 
are substantial savings to be realized from a faster rate of recovery. 
Cumulative savings realized when the fast growth alternative (Path A) i& 
compared with slow growth (Path B) come to $38.5 billion between 197 & 
and 1981. The lion's share of these savings result from reductions in 
unemployment compensation, which is much more sensitive to 
economic improvements than more stable expenditures for education 
manpower, social services, and public works programs. 


Programs and policies aimed primarily at- 

Classes of 




Increasing the 
of workers 

Providing income 
assistance to 

Expenditure Temporary 
programs. employment 
revenue sharing. 

Accelerated public 

Older Americans 

Summer youth 

Job opportunities 

Tax policies- 



Manpower train- 
ing and service 
veterans educa- 
tion, training, 
and rehabilita- 



Tax subsidies for 

WIN tax credits. 
Tax deductions for 
child care. 


Trade adjustment 

Tax exemption of 

2 Five-Year Budget Projections, Fiscal 1977-1981, Congressional Budget Office, 
January 26, 1976, p. 4. 


Figure 4. — Distribution of the anti-unemployment budget outlays (fiscal year 
1977 current service base) 5 percent growth path 


3 15 










Assistance To 
Hie Unemployed 

Employ ability 





[Billions of dollars] 

Programs and policies aimed primarily 
at — 

Classes of instruments 


of workers 



Expenditure programs: 

Temporary employment assist- 
ance 2 2.8 

Countercyclical revenue sharing 3 __ . 8 

Accelerated public works 3 NA 

Older Americans employment .1 

Job opportunities (EDA) 2 .5 

Summer youth . 5 

Higher education 2. 8 

Elementary, secondary, and voca- 
tional education 5. 4 

Comprehensive manpower assist- 
ance 2 .6 2. 3 

Manpower training and services 2 1. 5 

Veterans education, training, and 

rehabilitation 2 4.9 

Vocational rehabilitation .9 

Unemployment compensation 2 18. 8 

Total expenditure program. 5.2 17.7 18.8 

Tax policies : 4 

Win tax credits (*) 

Tax deduction for child care .4 

Tax exemption for education 1.7 

Tax exemption for unemployment 

compensation 2. 8 

Total tax policies 2. 1 2. 8 

1 At CBO estimate of economv (Path B). 

2 CBO estimate. 

3 Included in Second Concurrent Resolution but not enacted. 

4 Derived from JCIRT (c). 
*Less than $50,000,000. 
NA — Not available. 

Note: Numbers may not add to totals due to rounding. 



[Billions of dollars] 

Fiscal year — 


1976 lative, 
(est) 1977 1978 1979 1980 1981 1977-81 

Creatingemploymentdirectly 1 . 5. 1 4. 5 2. 8 2. 2 2. 2. 13. 5 
Increasing the employability 

of workers 2 18. 3 17. 8 18. 6 19. 5 20. 3 21. 3 97. 3 

Providing income assistance 

to unemployed individuals 3 . 19. 8 15.3 11.0 9.5 8.9 9.4 54.1 

1 Includes funds from manpower programs (pt. 504) for all years, and smaller 
amounts from countercyclical revenue sharing (pt. 450) for fiscal year 1976-77 
and from accelerated public works (pt. 450) for fiscal year 1976 and the Transition 
Quarter as specified in the U.S. Congress Second Concurrent Resolution on the 
Budget, fiscal year 1976. 

2 Includes moneys from education (501, 502), manpower (504), vocational 
rehabilitation (506), and veterans education, training, and rehabilitation (702). 

3 Unemployment compensation (603) consisting of regular and extended benefits, 
Federal supplemental benefits, and special unemployment assistance. 


[Billions of Dollars] 

Fiscal year — 


1976 lative 
(est) 1977 1978 1797 1980 1981 1977-81 

Creating employment directly 1 . 5.1 5.2 4.3 3.9 3.6 3.3 20.3 
Increasing the employability 

of workers 2 18.3 17.7 18.3 19.1 19.7 20.3 95.1 

Providing income assistance 

to unemployed individuals 3 . 19. 8 18. 8 18. 8 18. 2 16. 9 15. 3 88. 

1 Includes funds from manpower programs (pt. 504) for all years, and smaller 
amounts from countercyclical revenue sharing (pt. 450) for fiscal year 1976-77 
and from accelerated public works (pt. 450) for fiscal year 1976 and the Transition 
Quarter as specified in the U.S. Congress Second Concurrent Resolution on the 
Budget, fiscal year 1976. 

2 Includes moneys from education (501, 506), manpower (504), vocational 
rehabilitation (506), and veterans education, training, and rehabilitation (702). 

1 Unemployment compensation (603) consisting of regular and extended benefits, 
Federal supplemental benefits, and special unemployment assistance. 



Many current and proposed responses to unemployment involve 
creating incentives and making information available to workers and 
firms. Some create incentives for employers to hire workers while others 
enhance the incentives of workers to find jobs, 

If there is an absolute limit to the number of jobs that can be made 
available at any given time, then enhancing the employ ability of one 
individual may only mean that he or she will replace another individual 
in a job without producing any net reduction in unemployment. 3 
Even in periods of high unemployment, however, some jobs go unfilled. 
When, for example, some unemployed do not have necessary skills or 
when qualified unemployed persons are unaware of openings or live a 
substantial distance from available jobs, unemployment and unfilled 
openings can coexist. 

The matching of openings to skills has become increasingly difficult 
during the last 10 years because of changes in the composition of the 
labor force. In particular, the large increase in the number of working 
wives and teenagers who typically have higher unemployment rates 
than household heads has made achievement of 4 or even 5 percent 
unemployment, without creating severe inflationary pressures, more 
difficult. The demographic change of the last 10 years is shown in 
Table 8. 

By 1980, however, those born at the beginning of the post-World 
War II baby boom (1947) will be 33 while those born at the end (1957) 
will be 23 years old. Thus, the teenagers of 1975 will be ready to take 
full-time career jobs in 1980 if positions are available and if education 
and training programs have been effective. 



1965 1970 1975 

Share of the labor force: 

Household heads 59. 4 58. 8 57. 6 

Married men with wives present 48. 6 46. 5 43. 3 

Female household heads NA 7. 9 8. 9 

Teenagers (16-19) 7.8 8.8 9.5 

Women 20 and over 31. 3 34. 2 35. 6 

Share of the unemployed: 

Household heads 36. 4 34. 7 39. 1 

Married men with wives present 25. 5 24. 5 26. 1 

Female household heads NA 6. 9 8. 

Teenagers (16-19) 25.3 27.0 22.4 

Women 20 and over 30. 6 32. 7 33. 8 

NA — Not available. 

1 In fact, measured unemployment may increase if training or the availability 
of day-care facilities increases the labor force without increasing the number of 


Teenagers may become a smaller part of the labor force but the 
increase in female participation is expected to continue. It is difficult 
to tell whether the effect of the growing number of women who are 
permanently in the labor force — and therefore should have unemploy- 
ment rates similar to men in comparable circumstances — will offset 
the effect of the women who are entering or reentering the labor force 
after an extended period of absence. 

It is clear that the employment experience of secondary workers 
in a family is different from that of breadwinners. Many teenagers 
seek employment only during school vacations. Some mothers with 
school-age children seek employment only when schools are in session. 
The needs and skills of these groups must be matched with job op- 
portunities if the overall unemployment rate is to be reduced to the 
levels of the previous generation. 


Only if education and training programs foster skills that are in 
short suppl}' will there be a net addition to employment. Manpower 
training programs are not likely to be successful when unemployment 
is very high. As unemployment recedes, however, the need to match 
skills and jobs will increase. Otherwise, both unemployment and 
inflation will be higher than necessary. This suggests that it would be 
worthwhile to include training as a component of any public employ- 
ment program and to develop better training and information support 
for teenagers. 

The next few years could provide an opportunity to upgrade the 
skills of the labor force ij effective training programs can be mounted 
and if economic recovery can be counted on to provide jobs for those 
who have completed training. 

Although 43 percent of the jobs-oriented portion of the Federal 
budget is invested in training and rehabilitation for persons who 
cannot find work, no comprehensive review ever has been made of the 
effectiveness of those programs. 

Some very general conclusions about training and rehabilitation 
programs were reached in a 1975 review of 252 fragmented studies of 
various individual programs. 4 

The review supports only the broadest sorts of conclusions about 
the effectiveness of programs: (a) they have enhanced the earning 
power of trainees modestly; (b) they have not solved all the problems 
of people who have been enrolled in the programs; and (c) they 
cannot be judged failures. Because of differing assumptions among 
the studies, different data bases and differing methods of review, the 
conclusions are only tentative. A better evaluation is unlikely until 
there are experiments that compare the work experience of training 
program graduates with control groups of individuals with similar 
backgrounds who did not enroll in training programs. 

The best-designed study available for review concentrated on 1964 
graduates of training programs under the Manpower Development 
and Training Act. 5 

4 Perrv, Charles II., et al., The Impact of Government Manpower Programs (The 
Wharton School, 1975). 

5 Orley Ashenfelter, "Program Report on the Development of Continuous 
Performance Information on the Impact of the Manpower Development Act", 
Technical Analysis Paper No. 12 A, U.S. Department of Labor, October 1973. 


On the basis of his review, the author concluded that: 

(1) The training program increased the average annual earnings of 

graduates by $377 between 1965 and 1969. 

(2) Black males benefited more from the program than did white 

males, enhancing their earnings by an average $350 a year 
contrasted with an average increase of $250 a year for white 

(3) Both black and white females benefited most from the program, 

increasing their earning power by an average $550 per year. 

Other research establishes some general comparisons on cost effec- 
tiveness among some programs. Under Title I of the Comprehensive 
Education and Training Act, for example, earnings of participants 
were increased by $400 to $800 per year at a program cost in 1975 of 
$1,700 per enrollment; a relatively good return on the investment. 
On the other hand, Job Corps programs under Title IV of the Act 
increased annual earnings of individuals by only $200 to $400 at a 
cost-per-person of $3,421. 


Training enhances the value of a worker to a firm. Another way to 
provide an employment incentive is to lower the cost of labor to an 
employer. Serious consideration has been given to two proposals of 
this type. One is reduction in the minimum wage paid to teenagers 
(sometimes coupled with a training requirement). Another is to 
provide a wage subsidy. 

If there is a limited number of jobs, these incentives will only 
determine who will find work, not how many people will be employed. 
However, when there are vacant jobs such as delivering merchandise 
a subsidy or minimum rate reduction could increase employment. 

One possibility would be a pilot program oj limited wage subsidies for 
teenagers to try to bring down the very high unemployment rate in that 
group. The annual wage of a full-time employee receiving the minimum 
wage is now $4,600. The employer's payroll tax contribution for social 
security and unemployment compensation is now almost 9 percent. 
In addition, other fringe benefits might cost hundreds of dollars more. 
A subsidy of $500 for a year to cover these fringe benefits would 
reduce the effective wage by 10 percent. If the subsidy were paid for 
the first year of employment for newly hired 16 to 19 year olds, the 
cost might be $0.5 billion. Another approach would be to forgo both 
employee and employer contributions to social security for the first 
year of full-time teenage employment. The employer's cost would 
then be reduced by approximately $500 while the teenager would 
receive the same take home pay. 

It is difficult to estimate how much additional employment this 
small subsidy would produce. One drawback to the concept is that 
there may be an incentive for an employer to hire a teenager and fire 
him 1 year later. If the employer then hired a new teenager, he would 
once again be eligible for a $500 savings, whereas if he retained the 
old teenager, his savings would lapse after the first year. However, 
it would tend to help the teenager get his first job and it is an approach 
that merits consideration. 


Another approach is a $200 per-person-per-month tax credit avail- 
able to employers who increase their work force. An employer hiring 
labor at an average wage of $5 per hour would then save $1.25 an 
hour in unit labor costs. The staff can find no evidence that such a 
system has been tested in the United States, even on a pilot basis. 
But, in theory, the subsidy should give employers an incentive to biro. 
In order to limit the revenue loss, the credit could be phased out over 
18 months and the credit could apply only to employees in excess of 
the average work force prior to the introduction of a tax credit. 

In such a system, the direct costs of Federal support to the unem- 
ployed would be reduced and the psychological costs of unemployment 
to many workers and their families could be eliminated. However, the 
lost revenues could be substantial. 

A third alternative is to provide a subsidy for creating a shorter work- 
week, thereby spreading the burden of unemployment more widely. In 
some European countries, compensation is paid to workers who work 
4 days a week. Other approaches to increase labor force participation 
or ease the transition from school to work can also be considered. It 
is important to recognize, however, that these will not be very effective 
unless the demand for labor is increased. 


There are two types of income maintenance programs other than 
retirement and disability programs. One is unemployment compensa- 
tion, a temporary payment based not on need but on previous work 
experience and earnings. The second is welfare — food stamps, AFDC, 
Medicaid, and other semi-permanent income maintenance programs — 
based mainly on need, not on employment experience. Some families 
or individuals may be eligible for both types of assistance. The 
government may spend $199 to $231 billion for these programs over 
the next 5 years. (See Table 9.) 

Spending for non-retirement income transfer programs fluctuates 
during the business cycle, partially offsetting swings in economic 
activity and individual income. HEW estimates 35 percent more 
beneficiaries and (because the benefit per person for some programs 
increases with reduced income) a 71 -percent higher cost for cyclically 
sensitive transfer programs in the fourth quarter of 1976 because of 
the recession. 6 

Several major concerns have been voiced with regard to these 

— Is the patchwork of income support programs adequate to 

provide a decent standard of living for those who cannot work? 
— Do the programs provide equal treatment to those in similar 

— Does income maintenance create disincentives to work? 
The circumstances of 1975 added one further question: 
— can State and local governments in areas of high unemployment 

maintain the fiscal capacity to shoulder their share of this 

income maintenance burden? 

8 HPiW, Technical Analysis Paper No. 7, "The Cyclical Behavior of Income 
Transfer Programs: A Case Study of the Current Recession. " 


THE EMPLOYABLE, 2 1976-1981 

[In billions of dollars] 



1976 1977 1978 1979 1980 1981 1977-81 


Unemployment compensation: 

Supplemental benefits 3. 5 

Regular programs 16. 4 

Public assistance (AFDC) 5. 8 

Food stamps 5. 9 

Child nutrition and other food, 2. 7 

Housing assistance 2. 6 

Medicaid 3 2. 1 

2. 5 

0. 6 

0. 3 

0. 2 

0. 2 

3. 8 

13. 8 

10. 8 

9. 6 

9. 2 

9. 7 

53. 1 

6. 4 

7. 1 

7. 6 

8. 3 

8. 9 

38. 3 

6. 5 

7. 4 

8. 3 

9. 6 

10. 9 

42. 7 

3. 3 

3. 5 

3. 8 

4. 1 

4. 4 

25. 1 

3. 1 

3. 9 

5. 1 

6. 6 

8. 1 

26. 8 

2. 4 

2. 6 


3. 3 

3. 6 


Subtotal, Path A 



35. 9 





45. 8 

198. 7 


Unemployment compensation: 

Supplemental benefits 





16. 5 






79. 5 

Regular programs 





2. 9 






11. 2 

Public assistance (AFDC) 









8. 6 

37. 6 

Food stamps _ _ 





7. 5 





10. 4 

42. 5 

Child nutrition and other food_ 





3. 6 





4. 3 

19. 3 

Housing assistance 





3. 9 






26. 6 

Medicaid 3 





2. 6 




3. 5 

14. 7 

Subtotal, Path B 39. 41. 3 44. 46. 8 48. 7 50. 6 231. 4 


Path A - Path B 3. 3 8. 1 9. 1 7. 4 4. 8 

Cumulative difference 3.3 11.4 20.5 27.9 32.7 

1 Calculated from data supplied in CBO, "Staff Working Paper for 5-Year 
Projections, 1977-81." 

2 While these programs aid mostly employable individuals or family heads, 
some recipients are incapacitated and unable to work. Also, some able-bodied 
parents must care for young children if adequate child care is not available. 

s These outlays are one-fourth of the Federal share of medicaid; the remainder 
is spent for the aged, blind, and disabled. 

Many persons hesitate to look for work or accept a job if the take- 
home pay — salary net of work expenses, taxes, and the loss of income 
maintenance benefits — is too low. For example, the earnings limit 
which is linked to social security payments discourages employment 
for the elderly while a lack of day-care facilities and the cost of those 
that are available reduces female employment. In addition, the design 
of unemplo3^ment compensation and welfare programs may reduce 
work effort because benefits are reduced as income rises. 

In some cases, reducing the disincentives may increase measured 
unemployment during a recession. Removal of the disincentives, 
however, may be a clear addition to the social welfare once high 
employment rates are restored. 


In the case of unemployment compensation, generous benefits and 
extended periods of eligibility may also increase measured unemploy- 
ment. Some persons would drop out of the labor force if job 'search 
was not a condition for receiving unemployment compensation. A 
more serious concern is a possible reluctance to accept employment 
unless a job would provide substantially more take-home pay than 
unemployment compensation. 7 The possibility that unemployment 
compensation may be a deterrent to a vigorous search for work is one 
reason for the Administration's reluctance to renew the additional 26- 
week extension of insurance payments. An alternative is to make unem- 
ployment compensation less attractive ; by making the program means- 
tested (one would have to be both poor and unemployed to collect) 
rather than insurance, or by taxing the benefits (see p. 48). 

Extension and Revision of Unemployment Compensation 

The fiscal 1977 budget — on a current policy basis — would require 
approximately $19.2 billion for unemployment compensation. 8 

Currently, many State unemployment insurance funds are depleted 
and Federal loans have been extended to maintain the liquidity of 
programs in States where insured unemployment has been high and 
prolonged. Such loans totaled $8.5 billion in fiscal 1976 and it is 
anticipated that an additional $7.6 billion in loans will be required in 
fiscal 1977. The Administration has proposed an increase in unem- 
ployment insurance taxes to eliminate the trust fund deficit. The pro- 
posed increase in the payroll tax, however, will increase labor costs and 
thereby increase unemployment and the inflation rate. 

The massive unemployment which accompanied the 1974-75 
recession led to an extension of the maximum insurance eligibility pe- 
riod from 26 to 65 weeks under Federal Supplementary Benefits 
(FSB) program. In addition, Special Unemployment Assistance (SUA) 
was made available for workers who were not normally covered by 
unemployment insurance. The estimated cost of the latter program, 
including 26 weeks of benefits at the same level as that of unem- 
ployment insurance, is $1.3 billion in fiscal 1976. 

Levels of unemployment insurance benefits and the special program 
differ in benefit payments from State to State; these programs provide 
50 to 67 percent of the average gross weekly wage of manufacturing 
employees in the various States, up to some limit. However, since 
wages are subject to social security and income tax withholding while 
unemployment benefits are subject to neither, unemployment benefits 
generally replace between 60 and 80 percent of lost net income for 
workers making less than the limit. 

If lost fringe benefits are taken into account, however, replacement 
rates are overstated. 

The system provides two distinct kinds of services for the unem- 
ployed. In the case of an emplo3 r ee who is cyclically or seasonally out 

7 For an analysis of this issue see Stephen T. Marston, "The Impact of Unem- 
ployment Insurance on Job Search" and the ensuing discussion in Brookings, 
Pavers on Economic Activity 1.976:1, pp. 13-60. See also Martin Feldstein's report, 
"The Importance of Temporary Layoffs: An Empirical Analysis," in the 1975:3 
issue of the Brookings series. 

8 All budget figures in this section are based on CBO Path B, Five- Year 


of work, the benefits enable that employee to support his household at 
a reduced level until such time as his employer issues a recall. Kecent 
research indicates that 50 percent of all workers drawing unemploy- 
ment insurance ultimately return to work at the same job with the 
same employer. 9 In the case of an employee on indefinite layoff, the 
payment of benefits allows for a more intense and productive job 
search. To the extent that such a search goes on, the mobility of labor 
is enhanced as a direct result of the unemployment benefits provided. 

In addition, the current system of unemployment insurance affects 
total national employment indirectly b}^ helping to maintain the level 
of consumer purchasing power during periods of recession and high 
unemployment. It has been estimated that the system indirectly 
supports 500,000 to 1 million workers which, in effect, means that 
unemployment rate would be about one-half of one percentage point 
higher without the purchasing power represented by unemployment 

Combining Benefits and Training 

With all of its advantages, the unemplojnnent insurance program 
is not designed to serve one important function — increasing the 
employ ability of a worker who is drawing benefits. 

An alternative to a simple extension of the current system of 
unemployment compensation might shift the emphasis of Federal 
payments from income maintenance to increasing the employability 
of the unemployed. One possibility is to place a worker in a training 
program after some limited time on unemployment compensation 
(e.g., 26 weeks). If the unemployed participated in a retraining effort, 
at least two positive purposes would be served : 

(1) Benefit payments would provide recipients with an opportunity 

to upgrade skills and increase both their potential for employ- 
ment and their range of job choices. 

(2) The program would generate employment directly for those 

who staffed the training programs. 

If, however, the worker is only waiting to be recalled to his old job, the 
expense of training would be wasted. 

Undoubtedly many persons would accept paid training in lieu of 
unemployment compensation if the option was available. Making 
training or employment a requirement for continued compensation 
after, say, 26 weeks is clearly another matter. Whether the reduction 
in benefits for those who would rather forego unemployment compen- 
sation than undertake training is either appropriate or worth the 
increase in discipline problems is a matter of judgment. 

taxation of unemployment benefits 

The current unemployment insurance system fails to differentiate 
among the unemployed on the basis of need. To the extent that un- 
employed individuals were previously employed at high salaries, 
have employed spouses, or have substantial current income from 
investments, benefits are less important to sustain income levels or to 

9 Martin Feldstein, "The Importance of Temporary Layoffs: An Empirical 
Analysis," Brookings' Papers on Economic Activity 1975:3, p. 725. 


insure current consumption. All unemployment benefits are currently 
tax exempt. The decision not to treat these benefits as taxable income 
will reduce fiscal 1976 revenues by an estimated $3.3 billion, and fiscal 
1977 revenues by $2.9 billion. Taxing these benefits would increase 
the tax burdens only of those taxpayers with substantial income during 
the year from sources other than unemployment benefits. The resulting 
increase in Federal revenues could be returned to unemployment bene- 
fit recipients on the basis of need. 

AFDC, Food Stamps, and Medicaid 

In addition to the receipt of unemployment benefits, a number of 
those who work at low wage levels or who are subject to extended 
periods of joblessness also qualify to receive welfare payments in the 
form of Aid to Families with Dependent Children (AFDC), food 
stamps, and Medicaid. Like unemployment compensation, these 
income transfers are designed to maintain income, but unlike un- 
employment compensation, they are unrelated to employment experi- 
ence and are not financed by contributory trust funds. 

While it is impossible to quantify the cost of the above programs 
which represent income subsidies specifically to the unemployed poor, 
it is possible to quantify and forecast the spill-over impact of un- 
employment on expenditures in these welfare programs. Unusually 
high levels of unemployment during fiscal 1976 are expected to increase 
expenditures in AFDC over and above those which would have been 
incurred had full employment been achieved. The Department of 
Health, Education and Welfare (HEW) has estimated that AFDC 
outlays associated with the recession will exceed $3.9 billion. Of that 
figure, the Federal share will equal $2.0 billion (35 percent of the total 
Federal share). The HEW figures were predicated on an unemploy- 
ment rate of 8.7 percent actual versus a full employment rate of 5 
percent, or approximately $1 billion per percentage point. 

The current high level of unemployment will result in an increase in 
expenditures for food stamps during fiscal 1976 of approximately $1 
billion over the full employment level. Additional outlays in fiscal 1977, 
given an extension of unemployment benefits and SUA, should reach 
$0.9 billion in excess of outlays associated with a 5-percent level of 

Medicaid expenditures, of which the Federal share is equal to 55 
percent, also are responsive to cyclical fluctuations in employment. To 
the extent that prolonged periods of unemployment result in increased 
eligibility for AFDC and other programs, Medicaid expenditures are 
expected to increase by $1.1 billion in fiscal 1976 and by an equal 
amount in fiscal 1977 assuming the CBO unemployment rate assump- 
tion to be correct. 


Regardless of t ho ultimate disposition of any alternatives to the 
handling of unemployment compensation and special unemployment 
assistance, the Committee must reflect the extension or termination 
of these programs at current levels in the First Concurrent Resolution. 
Special Unemployment Assistance (SUA), established under Title 
II of P.L. 9.V567, terminates December 31, 1976. The Federal Sup- 
plementary Benefit (FSB) program which extends benefits to 65 weeks 


for unemployment compensation and 39 weeks for special compensa- 
tion expires March 31, 1977. Consequently, the Committee spending 
target must recommend either continued extension or termination. 
Termination would reduce outlays by $1.4 billion for unemployment 
compensation and $1 billion for special compensation. Such termina- 
tion, however, unquestionably would increase expenditures in Aid to 
Families with Dependent Children (AFDC) and food stamps. In the 
event that the extension of benefits under unemployment insurance 
and the new benefits associated with SUA were terminated, those 
States in which unemplo3Txient remained high would revert to a 39- 
week payment system under unemployment insurance. 

The assumed rate of economic recovery also has substantial implica- 
tions for future cost trends in income transfers for employables. As 
indicated in Table 9 (p. 45) , the more rapid reduction in unemployment 
assumed in the "fast growth" path (Path A) reduces out-year costs 
for these programs substantially as compared with expenditures for the 
same programs under the "slow growth" path (Path B). Largely due 
to reductions in clientele, the fast growth assumptions result in 
initial fiscal 1977 savings of $3.3 billion, peak savings of $9.1 billion 
in 1979, and eventual savings of $4.8 billion in 1981 when compared 
with program costs under slow growth assumptions. Cumulative 
savings over the full 5-year period sums to $32.7 billion. Savings peak 
in 1979 largely due to reductions in eligible clientele who are drawn 
back into the economic mainstream. Savings decline after 1979 
because the "fast growth" alternative results in more inflation as the 
economy approaches full emplo}Tnent and labor and resource markets 

Finall}^, the Committee must decide whether to recommend that the 
Senate accept the proposed increase in unemployment insurance taxes 
or some alternative. 


The final policy approach is programs that put persons to work 
directly: public works, anti-recession revenue sharing, and public 
employment. Each has advantages and disadvantages. 

(1) Public works programs typically produce useful products — roads, 
buildings, airports, and other necessities. Such projects employ 
construction workers, who are experiencing high unemployment. How- 
ever, because these workers must be paid full union wages and because 
expensive equipment and supplies also are required, the cost of such 
programs per worker employed is relatively high. 

Public works programs also have been criticized as anti-recessionary 
devices because the timing is difficult to control. Too much time passes 
before plans can be drawn, contracts let, and land purchased and the 
labor force finally hired. Similarly, projects will not necessarily be 
completed before the need for fiscal stimulus has passed. 

The timing problem can be avoided especially in light of the ex- 
pected duration of high unemployment. Financing can be restricted 
to projects that can be completed in 1 or 2 years — a period in 
which unemployment will certainly exceed desirable levels. (This is 
the restriction of Title 10 of Public Law 93-567; Public Works and 
Economic Development Act.) 

(2) A second direct employment program is anti-cyclical revenue 
sharing. The purpose in this approach is to moderate recession-caused 


deficits of State and local government and thereby avoid layoffs in 
this sector. This program has three advantages relative to public 
works. The net cost to the Federal government of each job created is 
less; the monies can be directed to those geographic areas most in 
need; and the moneys only flow when measured unemployment is 

(3) Public employment is the third alternative. It can have the lowest 
net cost per job created, especially if public employment replaces 
unemployment compensation or welfare. The biggest drawback is the 
administrative difficulty of effectively using the large numbers of 
persons involved and the concern that the program will be demoraliz- 
ing to workers and observers if the program deteriorates into leaf 
raking or other makework. The other drawback is the possibility that 
public employment workers will only displace regular public employees 
and produce no net gain in employment. 

However, properly designed and implemented, a public employ- 
ment program can partially meet other objectives very effectively. 
By providing income for families most in need, the major objectives 
of a large portion of the income maintenance program can be achieved. 
Moreover, by including some training, the future emplo}'ability of 
these individuals can be enhanced. 

Compared to a tax cut, public employment can provide public jobs 
in addition to the private sector positions created by the fiscal stimulus 
and thus provide more total jobs per dollar of Federal spending. 10 
Because public employment is likely to be the focus of so much debate 
and because there are so many variations on the theme, it is appro- 
priate to consider this subject further. 

Public Employment 

Public employment is frequently proposed as a program that will 
maintain and improve skills, accomplish national income support 
goals for a large portion of the unemployed population, and provide 
more jobs per dollar than any alternative program. On the other hand, 
public employment has been criticized as inflationar}^ a non-pro- 
ductive form of Federal spending, and as a program that only replaces 
regular local government workers with others on the Federal payroll 
leaving overall unemployment rates unchanged. 

It is possible to design a public employ ment program that will meet 
any one of the objectives or any of the criticisms noted above. How- 
ever, no single program can be a panacea for all unemployment nor 
can any justify all the criticism simultaneously. Each claim and 
criticism must be evaluated in terms of a specific program design or 
characteristics. The following characteristics are important. 


Is the program primarily a responso to the recession and is the 
target group, therefore, composed of people who were previously 
employed; or is the intent of the program to change the work experi- 
ence of those who are chronically unemployed or underemployed? 

10 Temporary Measures to Stimulate Employment: An Evaluation of Some Alter- 
natives. Congressional Budget Office, Sept. 2, 1975, p. 59. This CBO paper com- 
pares the impact of all the programs discussed in this section. 



Are there to be a limited number of positions distributed among 
labor regions on the basis of local unemployment conditions or is 
there to be a guarantee of some sort? If there is a limit to the number 
of positions, how will they be distributed (e.g., to veterans, to those 
who have exhausted their unemplo3^ment compensation, or at ran- 
dom)? If there is to be a guarantee, shall it apply to everyone, only 
those in need, or to family heads? 


Should pay be similar to other jobs in government, equal to what 
the applicant made previously, or less? Should positions be permanent 
or created for a limited period such as 12 months? 


If the purpose of the job is to maintain the income, skills, and 
dignity of the unemployed during a period of recession, then there is 
less need for training although there will be a need to find useful tasks. 
The implied goal of such jobs is transition out of anti-recession public 
employment into work in the private sector. However, if the purpose 
of the program is to help those chronically unemployed, then more 
training is required. The transition in this case is more likely to be to 
regular public employment, although training for private employment 
could also be a large part of the program. 


Should the work involve assistance in on-going public activities 
such as public safety or education, or should it involve special projects 
that would not otherwise be undertaken? How important is the value 
of the product compared to the maintenance of employment? 

With these five characteristics in mind, alternative public emplo}^- 
ment designs can be evaluated in terms of the previously mentioned 
objectives and criticisms. 


The primary objective of training programs is a better match of 
job openings and skills. Successful training within public employment 
programs should reduce inflationary pressures as the economy 

If public employment is overly attractive, however, firms would be 
forced to inflate their wage offers in order to induce workers to 
return to the private sector. The inflationary effect of public em- 
ployment can be avoided if the pay is low enough and/or the duration 
short enough so that job holders will return to regular employment 
when opportunities arise. A public employment program will not 
be inflationary if the wage is lower than the wage an individual is 
likely to be offered at regular employment. Nor will it be inflationary 
if the duration is restricted to, say, 12 months. It is clear, for example, 
that there is nothing inflationary about creating a work requirement to 
receive a wage no greater than current unemployment compensation. 


Finally, public employment could be inflationary if it interferes with 
job search. Therefore, it will be necessary to design public employ- 
ment programs to give the employees ample time for interviews or 
other work-seeking activities. 


An ideal program or mix of programs would assure that public 
employment jobs went to those most in need and that the value 
of the product produced by these employees compared favorably 
with other services provided by tax dollars. The ideal of course, 
cannot be achieved. A program designed to meet the income mainte- 
nance objective most efficiently would limit the money for overhead 
and materials required to produce a useful product. However, a pro- 
gram intended to produce a useful product would hire relatively high- 
wage construction workers for public works projects. Moreover, it is 
unlikely that the work product of public-employment dollars can 
compare favorably to that from other public dollars. Otherwise, these 
new activities would have been funded before those activities that 
are already receiving public monies. 

With a fixed amount of money for public employment, trade-offs 
must be made between objectives for income improvement itself. 
Money spent for training means either fewer jobs or lower salaries 
for those employed. 


Displacement has been a major criticism of recent public employ- 
ment programs. In some cases, State and local governments have 
hired public employment workers to displace those already on the 
State and local payroll. In other cases, workers have been laid off 
for some time required to qualify and then rehired on the public em- 
ployment program. The criticism has often erred in assuming that 
the money displaced has been "lost" as an anti-recession dev. re. 
However, the "lost" money acts as a disguised and somewhat clumsy 
anticyclical revenue sharing program for those governments who have 
used the funds in this way. 

If the problem could not be solved in any other way, displacement 
could be avoided completely by using the Federal Government as the 
employer. A Federal program is, however, unnecessary if programs 
require State and local governments to maintain their effort in other 


The displacement problem can be moderated to some extent by 
providing some sort of employment guarantee even though a guar- 
antee creates its own problems. One is cost. A guarantee makes a 
program open-ended and the cost high and uncontrollable. The diffi- 
culty is compounded if the guarantee induces secondary family work- 
ers to join the labor force. Another problem with a guarantee is work 
discipline, if the guarantee means that the sponsor must tolerate any 
behavior. A problem of a different sort can arise if the guarantee 
turns into a low-wage work requirement for eligibility for welfare. 


The cost can be kept within moderate limits by making the guar- 
antee apply only to families or unrelated individuals with little addi- 
tional income. For example, the guarantee might not apply to any- 
one in a family with income from other sources in excess of $5,000. 
The discipline problem could be solved if the Federal Government 
only guaranteed to pay the salary of the applicant. The worker would 
have to conform to the work rules of the sponsoring unit (govern- 
ment or non-profit agency) in order to remain employed. This re- 
quirement would alleviate the major problem of managing this large 
addition to the work force in an effective way and producing a val- 
uable product. However, antidiscrimination laws would have to be 
vigorously policed. Finally, the work requirement problem could be 
avoided if the pay (say $7,500 annually) exceeded support levels by 
enough so that most of the unemployed would want to take the job. 

A public employment program that was targeted on families in 
need would increase the direct employment but reduce the income 
maintenance portion of the "direct response" to unemployment. 
additional funds would also provide fiscal stimulus and create private 
sector jobs. A billion dollar program could create over 100,000 public 
jobs, more than 25,000 private jobs, and add no more than $300 mil- 
lion to the deficit. An example of how the "direct response" budget 
could be reprogrammed from income maintenance to direct employ- 
ment is outlined in the attached Appendix to this report. 



The direct response of the budget to unemployment reflects, for the 
most part, a system designed for relatively full employment. Educa- 
tion and training moneys are spent with the expectation that bene- 
ficiaries will find employment and be able to use the acquired skills. 
Unemployment insurance is primarily intended for those who are on 
temporary layoffs or temporarily between jobs. At relatively full 
employment most of the unemployed are new entrants or re-entrants 
to the labor force and the average duration of unemployment is less 
than 10 weeks. However, in a recession, job losers make up more of 
the unemployed and the duration lengthens. (See Table A-l.) More- 
over, expenditures for unemployment compensation rise while the 
return on public and private investment in training and education 


[Dollars in billions] 







Job losers 



benefits 1 


1965 to 1969 

3. 8 

9. 5 

2 $2. 7 

3 38. 3 


8. 5 

14. 1 

19. 4 

55. 4 

1 Fiscal years 1966-70 and fiscal year 1976 estimated. 

2 Annual average over 5-yr period. 

3 Annual average for 1967-69. Data in this categor}' not available prior to 1967. 

The depth of the 1974-75 recession led to a strengthening of the 
direct response to unemployment in income maintenance and to a 
lesser degree in direct employment programs. Unemployment com- 
pensation was expanded in coverage (via Supplementary Unemploy- 
ment Assistance — SUA) and duration (via Federal Supplemental 
Benefits — FSB). Regular unemployment insurance benefits also 
expanded automatically. The number collecting benefits from State 
insurance programs doubled between September 1974 and April 1975. 
Although the Congress expanded direct employment programs with 
the passage of legislation funding 300,000 public emplojment posi- 
tions, the biggest impact of unemplo3 7 ment on Federal expenditures 
was in income maintenance. 

There are few who expect a quick return to 1973 levels of unemploy- 
ment. Current policies describe a continuation of the strategy of 
unchanged expenditures for increasing employ ability, relatively modest 
increases in expenditures for direct employment, and continued 



primary reliance on income maintenance. (See Figure 4 and Tables 6 
and 7 in the text.) The purpose of this appendix is to describe an 
alternative strategy that shifts funds away from income maintenance 
toward direct employment and possibly training programs. 


The vehicle for describing an alternative strategy is a public 
employment program targeted on households with little other income. 
This targeting differs from the current strategy in which neither 
education, unemployment compensation, nor public jobs are dis- 
tributed on the basis of need. If the program is properly designed, 
the funds provided for direct employment can, therefore, improve on 
unemployment insurance as a way of meeting income maintenance 
needs. Moreover, if training is a component of the program, public 
employment can also be used to increase the employability of the 
work force. 

Public employment cannot be evaluated in the abstract; a judg- 
ment can be made only about specific programs in a specific economic 
and political context. A program offering workers higher wages than 
they are likely to obtain in the private economy will clearly be more 
inflationary than one that does not. The state of the business cycle is 
also important. Only when there is relatively full employment will 
federally financed public employees be likely to displace other State 
and local workers or take workers from the private sector. Finally, if 
the budget deficit is the constraint on the amount of economic stimulus 
policymakers are willing to provide, then public employment can 
provide more jobs per dollar than any other feasible alternative. 
Given the high rates of unemployment projected for the next few 
years under even the most favorable assumptions and the political 
desire to limit the deficit, there is no conflict between 'public and private 
jobs over the next few years. 

The choice is not between good, private jobs, and not-so-good 
public jobs, but rather whether public jobs should be created in 
addition to the private jobs. With the number of unemployed ex- 
pected to exceed 6 million in 1978 an expansion of public employment 
will increase, not decrease, private employment. Moreover, the 
stimulation to the private sector of the public salary (less unemploy- 
ment insurance) is at least equal to that of a tax cut. 

Program Description 

Assume that the program will provide 750,000 positions, the number 
of positions and wage rates would be : 

500,000 full-time jobs paying $7,500 annually for households 

containing children (Class A job). 
150,000 half-time jobs paying $5,500 annually for single-parent 

households containing children (Class B job). 
50,000 full-time jobs paying $6,000 annually for two-adult 

households (Class C job). 
50,000 full-time jobs paying the minimum wage ($4,800 annually) 

for single-person households (Class D job). 


Eligibility for these jobs will be restricted to those who have been 
on unemployment for 15 weeks or whose family has been on welfare 
15 weeks. Jobs will be distributed on the basis of local unemployment 
rates. Within the local area, a certain proportion of jobs will be tar- 
geted on those who have exhausted their unemployment compensation. 
Households whose income from sources, other than unemployment 
compensation or welfare, exceeds $5,000 annually ($1,250 in the 
previous quarter) will be ineligible. The annual income limit would 
be $2,500 for households without children. With these rules, only one 
person from each household would be eligible. 

Sponsors would be State and local governmental units or nonprofit 
units. These would receive $20.00 a week to cover administrative 
costs and fringe benefits for each enrollee in Class A jobs and propor- 
tionately less for those in the other categories. 

Fringe benefits and terms would be as follows : 

Enrollees must leave the program after 12 months for a period of at 
least 15 weeks during which time unemployment compensation and/or 
welfare would resume. Employees would be entitled to participate 
in the sponsor's health insurance plan but not the retirement plan. 

Increased Cost of the Direct Response to Unemployment 

The changes in the direct response budget would be as shown in 
Table A-2 if the following assumptions are correct: 

(1) That the average enrollee in the Type A, C, and D jobs would 

otherwise be receiving $65 a week in unemployment com- 
pensation and food stamps. 1 

(2) That enrollees in Type B programs would otherwise be receiving 

$150 per month from the Federal Government for welfare 
and food stamps. 

The change in the direct response budget is shown in Table A-2. 

1 Seventy dollars was the average weekly Unemployment Insurance (U.I.) 
payment in the first 10 months of 1975. The benefit received by the average 
enrollee could, however, be either above or below this figure. Enrollees receiving 
U.I. pajrments are likely to be household heads receiving more than the average 
payment. As of January 1976, the maximum weekly benefit ranged from $60 to 
$139. On an employment weighted basis, the average maximum is $105. Among 
families with an unemployed household head and income under $5,000, 35 percent 
received food stamps. The average monthly bonus was $84 for families with an 
unemployed household head. The participation rate and average payment is 
likely to be higher for poor families where the household heads have been un- 
employed for an extended period. These overestimates of the net program cost is 
offset because some enrollees would not be receiving U.I. benefits if they are head- 
ing welfare families and/or have exhausted their benefits for part of the work 
period. The $65 average weekly payment is consistant with the following break- 
down of enrollees: 35 percent receiving $95 weekly in combined unemployment 
compensation and food stamps ; 40 percent receiving $75 in unemployment com- 
pensation; 10 percent receiving $20 in food stamps; and 15 percent receiving 
nothing at all. 




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Offsetting Indirect Effects 

The indirect effect of the additional Federal expenditures on the 
private economy will partially offset the net increase in the direct 
response budget. The increase in the deficit will be less than $3.5 
billion because enrollees will spend their additional income increasing 
sales and production in the private sector. The $3.5 billion increase in 
the direct response budget is likely to have a "fiscal multipler" of 1.5, 
and thus increase private GNP by $5.2 billion. The additional con- 
sumer demand will increase private employment by 125,000, increasing 
Federal revenues by $1.5 billion and reducing unemployment related 
expenditures by $200 million. Under these assumptions, a program 
providing 750,000 targeted public employment positions will add $1.8 
billion to the deficit — $2,400 per public job or $2,100 per job if the 
private jobs created by the economic stimulus are also counted. 

The effect on State and local budgets will not be small either. The 
reduction in welfare will save these jurisdictions $0.2 billion. More 
importantly, the stimulus to the private economy will increase their 
revenues and further lower welfare costs by another $0.6 billion. In 
total, the savings will be $0.8 billion, or over a $1,000 per employee, 
if the foregoing assumptions are correct. 

The savings to State and local governments are overstated to the 
extent that sponsors are required to contribute more than $1,000 per 
job in administrative costs, fringe benefits, and training. The savings 
are understated, however, if there is any displacement of regular 
workers by these new enrollees or if the reduction in the non-welfare 
unemployment saves these jurisdictions some money. Of course, if 
there is displacement of regular workers then the net new jobs created 
by this program is also overstated. 


March 24, 1976 


TO: Senator Cranston * 
FROM: Arnold Packer 


We have estimated how the net cost per job would change if the public 
employment program described 1r. the Budget Committee staff paper entitled, 
"Employment," was changed as follows: 

(1) The average annual wage was changed from $6,820 to $6,000. 

(2) The average annual cost per job was changed from $7,733 to $7,300. 
The other assumptions remained unchanged. Namely, 

(1) 32 percent of the job holders received only unemployment 
compensation of $75 per week. 

(2) 28 percent received food stamps of $20 per week In addition to 
$75 weekly 1n unemployment compensation. 

(3) 20 percent received $35 per week In food stamps and the federal 
share of welfare paympnt-c 

(4) 8 percent received only food stamps equal to $20 per week. 

(5) The remaining 12 percent receive nothing from the federal 

The table below gives the cost for a million jobs program. Both the 
direct and indirect costs are roughly proportioned to the number of positions 
the costs for programs of different sizes can be calculated easily. For 
example, a 700,000 jobs program would have a gross, direct, and net 
cost of $5.1 billion, $2.9 billion, and $1.5 billion respectively; or a 
300,000 jobs program would have a gross, direct, and net cost of $2.2 billion 
$1.3 billion, and $0.7 billion respectively. 


Gross Cost: 

1 million x $7,300 = 

$7.3 billion 

Less Income Maintenance Savings 
Equals Direct Cost 

3.1 billion 
$4.2 billion 

Less Savings from Economic Stimulus 

$ 2.0 bHUon 
$2.2 billion 

to Private Economy 

Equals Net Cost 




This paper was prepared for the use of the Senate Budget Com- 
mittee in connection with its markup of the First Concurrent Kesolu- 
tion on the Budget for Fiscal Year 1977. 

The report was prepared by Franklin Jones, Arnold Packer, Heather 
Ross, and Lauren Walters of the Senate Budget Committee staff and 
by Joel Bergsman and Peggy Cuciti of the Congressional Budget 

Edmund S. Muskie, 




I. Introduction and Summary 

While the Federal Government has maintained a roughly constant 
20 percent share of GNP in the postwar period, State and local 
governments have increased their share significantly — from 5.3 
percent of GXP in 1946 to 15.3 percent in 1975. An important source 
of support for this growth has been increasing Federal grants-in-aid, 
which have grown as a proportion of both Federal and State and 
local expenditures. Such grants, currently over 600 in number and 
$60 billion in dollar amount, and present in virtually every function, 
reflect the greatly increasing scale and complexity of Federal-State- 
local fiscal and administrative relationships. 

Fiscal year 1977 presents a significant decision point with respect 
to those relationships. The combination of expiring existing legislation, 
major Presidential proposals, and significant Congressional 
initiatives gives the fiscal year 1977 budget a potentially key role 
in defining the future mix of funding and spending responsibilities 
among Federal, State and local governments. 

Expiring Legislation 

General revenue sharing, which reaches the end of its initial 5-year 
funding period on December 31, 1976, and the Law Enforcement 
Assistance Administration,* a Johnson-era block grant which has 
been renewed with modifications twice and currently expires on 
September 30, 1976, are both up for renewal. The President has 
recommended extension of both, for 5 and three-quarters and 5 
years, respectively, with funding levels somewhat below those pro- 
vided by current policy. 1 

Presidential Proposals 

The President proposes to consolidate 59 categorical grants into 
four block grants in the areas of health, education, social services, 
and child nutrition, and to phase out 270.000 CETA public service 
jobs administered by States and local governments. Spending reduc- 
tions connected with these and other Presidential recommendations 
would reduce total grants to State and local governments by 13 
percent below current policy level, and cut the dollar amount of aid 
($60.5 billion) below that provided in fiscal year 1976 ($62.9 billion 
under current policy). 

1 Current policy is the level of real spending consistent with the Congress' 
Second Concurrent Resolution on the Budget for fiscal year 1976. 



Congressional Initiatives 

The Public Works Employment Act of 1975, vetoed by the President 
and due for Congressional reconsideration, contains innovative 
proposals for countercyclical financial assistance to State and local 
government. 2 At proposed annual funding levels of $500 million plus 
$250 million for each one-half percentage point of national unem- 
ployment above 6 percent, countercyclical assistance would pay out 
SI billion in fiscal year 1977 if unemployment averaged 7 percent 
over the year. The Congress is also considering substitutes for the 
exclusion from Federal income taxation of interest on municipal 

This paper is an effort to put these individual budget decisions in the 
broad context of evolving Federal-State-local fiscal and administrative 
relationships. The next section provides backgroimd information on 
existing State-local grant programs and on the President's fiscal 3'ear 
1977 grant proposals. Section III discusses objectives of Federal 
grants-in-aid, and arguments for and against different objectives and 
techniques. Section IV presents individual fiscal year 1977 spending 
issues in some detail. The concluding section explores several possible 
future directions for Federal-State-local fiscal and administrative 
relations, and the sets of fiscal year 1977 spending decisions which 
correspond to each. Directions considered are (1) continue the growth 
of Federal grants to State and local governments, although perhaps 
not at recently experienced rates, without major change in the mix or 
structure of grants; (2) continue the trend toward reduced Federal 
control over use of grant mone}~s through adoption of general revenue 
sharing and block grants, and aim for reductions in grants, or stabili- 
zation at existing dollar levels, either now or in the future as a result 
of greater State-local spending flexibility; and (3) reduce general 
and some categorical support for State and local governments and 
federalize key national services to which those governments presently 
contribute. The conclusion is that spending decisions consistent with 
any of these directions can be made this year, and that the avail- 
ability of countercyclical assistance provides the flexibility to move in 
desired directions without being inhibited by the current recession- 
induced strains on State-local budgets or getting locked into un- 
wanted permanent funding commitments. Countercyclical assistance 
also enhances national economic recovery by providing coordinated 
built-in stabilization across the public sector. 

II. Current Programs and the President's Proposals 

Current Programs 

The estimated outlays of $62.9 billion for State-local aid in fiscal 
1976 represent an increase in numbers of programs as well as in 
budgetary significance over the last decade. In 1966 there were fewer 
than 350 programs with outlays of $13 billion, comprising 9.6 percent 

2 Countercyclical assistance has recently repassed the Senate as part of S. 3201 
the Public Works Employment Act of 1976. This new legislation provides the 
same amount of assistance as the earlier bill, but utilizes a more sensitive trigger- 
ing mechanism and spreads the money more broadly. 


of the Federal budget. If current policy levels are maintained, outlays 
in Federal grant programs will be $69.8 billion in fiscal year 1977, or 
16.8 percent of total Federal spending (see Table 1). While Federal 
grants have been increasing as a proportion of both Federal and State 
and local outlays, Federal control over the use of grant funds has 
been declining due to introduction of general revenue sharing and 
shifts from categorical to block grants. Categorical grants comprised 
98 percent of Federal assistance in 1966; by 1976 the proportion had 
dropped to 76 percent. 



[Billions of dollars] 

Program type 


1976 1 

1981 1 

General assistance- 

0. 2 

7. 7 

8. 3 

Block grants 

7. 5 

9. 4 

12. 8 

47. 7 

62. 1 



62. 9 

79. 8 

Percent of total Federal outlays (per- 

cent) _ _ " _ 

9. 6 

16. 8 

14. 2 

Current policy levels. 

State governments receive more direct Federal grant funds than local 
governments, although their share has declined from 88 percent in 
1969 to 76 percent in 1974. The increase in the share of local govern- 
ments is largely attributable to the $4 billion per year they receive 
from revenue sharing. However, State governments redistribute a 
portion of their Federal grant funds to local governments. Since no 
data are available on the extent of these pass-throughs, a precise 
determination of the ultimate distribution of Federal funds is not 

In two important grant programs, Medicaid and AFDC, the grant 
funds are in essence passed through to individuals. In other grant 
programs, funds are spent by recipient governments to provide serv- 
ices; for example, schooling, day care, highways and law enforcement. 
In many cases, State and local governments are required to contribute 
matching funds to the federally supported activities. 

The percentage of total Federal outlays in each budget function 
accounted for b}~ grant programs is shown in the first three columns of 
Table 2. 

The distribution of total Federal aid among the several functions 
is exhibited in the second three columns of Table 2. In 1974, income 
security, and education, employment training, and social services 
received the most grant funding/However, the relative importance of 
these functions, as well as of commerce and transportation, has de- 
creased over time. The shift toward general purpose aid is shown by 
the increasing share of total grant outlays found in the revenue sharing 



Grants as a percent Percentage 
of total Federal distribution of 
outlays for each grant outlays 

Function function among functions 

Fiscal year Fiscal year 








National defense. 


International affairs 


Natural resources, environment, 


1 fi 

O I 














Commerce and transportation 








Community and regional devel- 

opment _ _ 








Education, training, employment, 
















Income securitv _ _ 








Veterans benefits _ _ _ 


Law enforcement 







General government-. 





Revenue sharing and general 

purpose fiscal assistance 














Source: Office of Management and Budget, Federal Government Finances 
(supplemental material to fiscal year 1977 Budget). 

In addition to Federal budget outlays under grant programs, State 
and local governments are assisted by Federal tax espenditures. Major 
items are detailed in Table 3. All of the tax expenditure items provide 
assistance of a general nature to State and local governments. The 
bond interest exclusion allows State and local governments to borrow 
at lower interest rates, but the resulting savings to them are less than 
the revenue lost b}' the Federal Government. The reduction for State 
and local taxes allows State and local governments to raise revenues 
without raising net tax burdens by an equivalent amount. 


[Billions of dollars] 

Tax expenditure 19G7 1076 

Exclusion of interest on State and local debt 1. 8 4. 2 

Deductibility of nonbusiness State and local taxes (other than on 

owner-occupied housing) 2. 8 7. 1 

Deductibility of property taxes on owner-occupied homes 1. 8 3. 7 


Finalh T , State and local budget positions are affected crucially by 
general economic conditions and thus by the degree of overall stimulus 
or restraint which Federal policy chooses to apply to the economy. 
Each extra percentage point of unemplojuient above full employment 
creates a $6 billion gap between State and local income and outlays, 
as tax revenues fall off from anticipated levels with reduced economic 
activity and demands for public services on the part of unemployed 
and other financially strapped people increase. Inflationary bursts 
also strain State and local government budgets, since they tend to 
increase interest costs, wage and salary demands of personnel, and 
prices of purchased goods more than they do revenues. 

The President's Budget 

The President's fiscal year 1977 proposals for aid to State and local 
governments would reduce both Federal spending and Federal 
control. Proposed grant outlay totals are $60.5 billion, or about 13 
percent below current policy budget estimates. Table 4 contrasts the 
President's recommendations with current policy by function, with 
proposed grant consolidations shown in parentheses. Consolidations 
account for approximately 40 percent of cutbacks recommended by 
the President. However, most of the other proposed cutbacks come 
from the same human resources areas. Key reductions are as follows: 

— $1.6 billion in community and regional development, where the 
President omits outlays expected as a result of the Public 
Works Employment Act of 1976. 

— $4.6 billion in education, training, employment, and social 
services, where the President plans reductions in public 
service employment and education. The implications of his 
jobs proposals are discussed in a companion paper on 

— $1.7 billion in health, where funding proposed for the Financial 
Assistance for Health Care Act is less than current policy 
estimates for the* replaced categorical programs, including 

— $1.0 billion for income security, where the proposed child nutri- 
tion block grant is confined to poor children. 

The President's block grant proposals would reduce Federal control 
over State and local programs. Recipient governments would be 
freer to allocate funds to their own high priority uses, and the proposed 
elimination of matching requirements in many programs would 
further increase State-local discretion over their spending and taxing 
patterns. This greater flexibility could mean efficiencies in the provi- 
sion of State local services and thus a reduced need for Federal grant 
support. It could also mean abandonment by States and localities 
of programs which the Federal Government initiated and previously 



[Billions of dollars] 

CBO Presiden- 

President's current tial 

Function budget policy reduc- 

tions 1 — 

1976 1977 1976 1977 1977 

450 Community and regional develop- 

<q ment____~ 4. 3. 9 4. 8 5. 5 1. 6 

500 Eduoation, training, employment 

and social services 14. 4 12. 5 16. 4 17. 1 4. 6 

(Education consolidation) (3.2) (3.3) (. 1) 

(Social services consolidation) (2.5) (2.6) (. 1) 

550 Health 10. 10. 2 10. 2 11. 9 1. 7 

(Health consolidation) (9. 0) (11. 2) (2. 2) 

600 Income Security 11. 2 11. 4 11. 12. 4 1. 

(Child nutrition consolidation) (2.0) (3.2) (1.2) 

Subtotal, human resources 
and Community and Re- 
gional Development 39. 6 38. 42. 4 46. 9 8. 9 

(Consolidations) (3.7) 

300 Natural resources, environment and 


400 Commerce and transportation 

750 Law enforcement and justice 

Others . 

Subtotal physical resources and 
law enforcement 

Revenue sharing and general pur- 

Total grants 59. 8 

3. 1 

4. 5 

2. 9 

4. 6 


8. 2 


8. 6 

9. 4 


. 8 

. 8 

. 9 

. 8 


. 8 

. 9 

. 8 

. 7 



12. 9 

15. 2 

13. 2 

15. 5 


7. 2 

7. 3 

7. 3 

7. 4 


59. 8 

60. 5 

62. 9 

69. 8 



1 From CBO current policy. 

Note. — Numbers may not add due to rounding. 

III. Objectives of Federal Assistance 

Along with the complex pattern of Federal-State-local fiscal and 
administrative relations goes a complex set of Federal policy objectives 
and a complex set of arguments for and against different Federal 
assistance goals and mechanisms. This section considers arguments 
and counterarguments for (1) general support of State-local govern- 
ment with little or no Federal control over the use of funds, (2) 
categorical support for particular vState-local activities, and (3) block 
grant support for broad functional areas of spending. 

General Support 

General support can take the form of continuing support, with 
funds steadily available year after year, or periodic support in times 
of general economic downturn — for example, the current recession — 
or specific fiscal crisis — for example, New York City. The basic 
arguments for continuing support are administrative ease and equity. 


There are economies to be realized from operating a single, large-scale 
tax system and sharing its proceeds, as opposed to carrying on a 
multitude of smaller, competing systems. 1 Furthermore, the sharing 
rule can promote nationwide equality in public services by giving to 
poorer areas more than their proportional share of the revenues — 
that is, more than the proportion contributed by their citizens. More- 
over, since the Federal tax mechanism, aside from social security 
taxes, is more progressive than the alternative State and local mechan- 
isms, the tax burden can also be distributed more equitably nation- 
wide based on ability to pay. This nationally supported equity helps 
poor areas achieve an adequate level of public services without 
increasing their own tax rates so high that they drive significant parts 
of their already meager tax base out to better-off, lower tax areas. 

The chief mechanisms of continuing general support are (1) general 
revenue sharing, and (2) tax expenditures such as Federal income tax 
deductions for non-business State and local taxes and exclusion of 
interest on State and local bonds. 

Periodic support of two kinds has received attention recently — 
antirecession grants and assistance to jurisdictions in fiscal crisis. 
The arguments for periodic support are the need for a nationally 
coordinated stabilization policy and the greater fiscal capacity of the 
Federal Government. With regard to stabilization, only the Federal 
Government has the ability to mitigate successfully swings in economic 
activity which affect the country as a whole. The greater fiscal capacity 
of the Federal Government assists it in meeting this stabilization 
responsibility, and also allows it to assist smaller jurisdictions which 
experience extreme fiscal strains. Failure to help State and local 
governments weather individual crises or nationwide recessions will 
often necessitate fiscal responses by them which undermine general 
financial stability and work against national economic recovery. 
Mechanisms for periodic general support include countercyclical 
revenue sharing and non-recurring grants, loans or loan guarantees 
to jurisdictions in ciises. 

Arguments against general support center principally on account- 
ability. State-local governments which spend the money have it given 
to them rather than having to impose the necessary taxation on their 
own jurisidictions — they may not be as careful spenders as they would 
be if they had to raise the funds themselves. Citizens will be opposed 
to unresponsive or inefficient spending, but not as aware or as opposed 
as they would be if they were asked to increase their own individual 
taxes to pay for it. An extreme form of this accountability argument 
holds that availability of bailout aid to fiscally threatened jurisdic- 
tions will reward and encourage mismanagement. 

The companion argument to accountability says that State and 
local governments can reform their tax laws and support themselves. 
Any lack of equitable and growth responsive taxes, notably significant 
progressive income taxation, results from decisions by those jurisdic- 
tions themselves, and is not a sufficient reason for Federal aid. Indeed, 
State and local governments have in recent years been turning in- 
creasingly to reliance on income taxation and their overall revenues 

1 These economies have sometimes been overstated. They cannot be fully 
realized unless individual State and local taxes are eliminated entirely, which 
seldom occurs. Also, they can be obtained partially by piggybacking State and 
local income taxes on the Federal tax system, as some jurisdictions now do. 


as a proportion of GNP have grown steadily since the 1950's while the 
Federal Government's share remained about constant. Through Fed- 
eral tax expenditures in the form of income tax deductions for State 
and local taxes paid, the Federal Government currently makes it easier 
for State and local governments to raise taxes, since part of their rise 
is automatically offset by lower Federal taxes. Further sweeteners or 
sticks are available to the Federal Government to induce further 
reliance by State and localities on their own tax revenues. 

Categorical Support 

Categorical support — that is Federal aid earmarked for specific 
purposes — is generally defended on the grounds of spillovers or na- 
tional purposes. Spillovers occur when a jurisdiction which makes 
expenditures is unable to capture the full economic benefits of those 
expenditures. It is therefore likely to underinvest in those activities. 
Examples are interstate highways and water pollution controls, public 
education in a mobile society, and experimental programs which may 
identify successful innovative approaches which are then free for 
others to adopt (although Federal support in the last case is also 
defensible on grounds that the larger Federal Government is better 
able to invest in risky new experimental approaches) . The nation as a 
whole can capture the full benefits of such expenditures, and therefore 
the National Government is an appropriate source of funds for them. 

The national purposes argument recognizes different spending 
priorities between Federal and State and local governments. These 
differences most often occur with respect to programs directed at 
particular population subgroups, especially those subgroups which 
are relatively small, widely dispersed and not-well-off economically. 
State and local governments may prefer not to tax their constituents 
heavily to provide services for the poor or for generally low-produc- 
tivity people, since that may tend to attract those people, who are a 
drain on resources, and drive out others who are healthy contributors 
to the tax base. The recipient groups will, in general, be so sparsely 
represented and economically and politically weak that they may have 
difficulty capturing much of a share of expenditures for themselves. 
If the Federal Government gave general support to states and locali- 
ties, those jurisdictions might not choose to spend the money on such 
recipient groups, but providing the money with requirements for its 
use can succeed in getting the desired services provided. 

Traditional mechanisms far categorical support are categorical 
grants, with or without matching requirements. Open-ended grant- 
with matching requirements reduce the cost to State and local govern- 
ments of providing specified services, and leave it to those govern- 
ments to decide whether and to what extent to provide the reduced 
cost services. This is a pure price subsidy which encourages but does 
not compel State-local spending along specified lines. However, other 
requirements regarding the level of services may also be attached, as 
is the case with matching giants for entitlement piograms where 
everyone who i> eligible must be served, and usually at some minimum 
service standard. In practice, decisions to participate in Federal 
matching grant programs often take on the characteristics of an all- 
or-nothing choice. Categorical gr-iints without matching resemble 
more a contracting arrangement, with the Federal Government 
retaining States and localities to cany out federally defined programs. 


Arguments against categorical grants concern the distortions and 
inefficiencies of earmarked funds and the attendant erosion of citizen 
control over and support for government. Distortions occur when 
State and local officials allocate their own revenues so as to maximize 
Federal grant money rather than to meet the priority needs of their 
constituents. They may do this through failure to think through their 
own priorities, or through political pressure to capture every available 
federal dollar. Inefficiencies occur because the people who make the 
policies and write the administrative rules are not the people who 
carry them out. The Federal Government must work through 50 
States to get its programs implemented the wa}^ it wants, and must 
monitor State performance. State governments face length}^ redtape 
to meet complex Federal standards and administrative rules and must 
often hire special staffs to go after Federal funds and to meet Federal 
reporting requirements. They lose flexibility to tailor levels and 
types of service to their particular needs and to reprogram funds — 
both Federal and their own — as changes in needs occur. The split 
between policy makers and program operators leads to buck passing — 
the former blame the latter for mismanagement and the latter the 
former for poor polic-^ design, overregulation, and underfunding. 
No one takes full responsibility, and citizens, finding no place to 
successfully lodge complaints or participate in reform, develop apathy 
and distaste for government. 

Responses to the problems of categorical grants have tended to go in 
two directions — proposals for federalization of programs and proposals 
for block grants. Federalization is suggested where the objective is 
to distribute resources to individuals nationwide and to relieve State 
and local governments of the burden of contributing to and administer- 
ing the redistributed funds. Examples are welfare reform and na- 
tional health insurance. Block grants are proposed when some loosen- 
ing of Federal strings is desired to enable States and localities to pursue 
their own spending priorities with more flexibility. 

Block Grant Support 

Block grants provide a pool of money, to States or directly to local 
governments, for spending within relatively broad functional areas— 
for example, community development or job-related education and 
training. These grants are intended to provide flexibility to recipient 
governments in establishing spending priorities for individual pro- 
grams, while retaining broad influence over the level and mix of pub- 
lic services and promoting a minimum level of key services nationwide. 
Block grants which do not change pattern of spending from what it 
would otherwise be are identical in effect to additional general revenue 
sharing. This will be the case if the receiving governments can be 
expected to spend more on the activities supported by block grants 
than the amount of the block grants themselves. Then, for example, 
if the Federal Government cuts back the law enforcement block grant 
and puts more into a child nutrition block grant, the State can simply 
reallocate its own funds out of child nutrition and into law enforce- 
ment so as to achieve the service mix it wants. This would appear 
to be the case in those present and proposed block grants where the 
Federal grant money is only a small portion of State spending in the 
block grant area — for example, law enforcement, education, and 
child nutrition. It is less likeh' to be true in areas such as commun- 

72-678—76 6 


ity development and employment and training where the Federal 
Government provides a substantial share of the dollars spent. Given 
the complex — and at the moment largely unknown — pattern of State 
block grant pass-throughs to localities, it may be true that even 
limited Federal dollars are indeed the marginal dollars in some local 
jurisdictions and are in fact helping to raise service levels in some 
places. Also, it is often the case that some strings and performance 
standards are applied to block grants — for example, Presidential 
proposals that all child nutrition moneys go to poor children. These 
requirements may be effective in influencing State-local spending 
patterns, but they do so, of course, to the extent that they partake of 
the characteristics, and the rigidities, of categorical grants. 

While the effect on State and local spending patterns of moving to 
block grants is uncertain — and no doubt very different for different 
States and different functional areas — the basic premise of block grants 
is clear. It is that less Federal control over the use of Federal grant 
funds is desirable and that States are expected and intended to use 
their new discretion to change their spending patterns. Why should 
the Federal Government favor this change? Federal spending in areas 
that are principally State and local functions began in large part be- 
cause of concern that certain important services, especially services to 
poor and handicapped people, were not being equitably or adequately 
provided. Moving back from this categorical spending must mean 
either that Federal priorities have changed, or that they have not 
changed but (1) States are now expected to support them voluntarily, 
or (2) categorical grants have proved to be inefficient means to 
achieve them. It is important to distinguish these possibilities. If it is 
true that Federal, State and local priorities now essentially coincide, 
either because Federal objectives have changed or because State and 
local orientations have changed, then block grants may be a good 
method of funding State and locally provided services, although 
another answer would be to get the Federal Government out of the 
grant business. However, if the problem is that Federal grants have 
gotten out of hand in number and complexity as tools for achieving 
distinctive Federal goals, then the responsible answer is to weed out 
and improve the categorical programs rather than to give the money 
to someone else and let them decide what to do with it. 

IV. Fiscal Year 1977 Budget Issues and Options 

Program Summary 

General revenue sharing was first enacted in 1972. Under current 
law the program expires on December 31, 1976. Outlays in 1975 were 
$6.1 billion; current policy levels for 1977 would be $6.6 billion. This 
amounts to roughly 2){ percent of projected State-local revenues from 
all sources. Funds are distributed to all 50 States and some 39,000 
local governments, according to a formula which takes into account 
population, tax effort, and per capita income. Local governments 
receive about two-thirds of the funds. 

The President has proposed renewal through 1982, with funding of 
$6.5 billion in 1977 and annual increases of $150 million thereafter, 
consistent with present law. 


Issues and Options 

More than any other program, budget issues related to general 
•revenue sharing center on Federal control over State-local spending, 
and distributional impacts. As it stands, the program uses the Federal 
tax system or borrowing power to obtain money and distribute it to 
lower levels of government with virtually no strings attached. Richer 
jurisdictions contribute proportionately more than they receive, and 
poorer ones receive proportionately more than they contribute. 

If the program is to be renewed, the funding level is an obvious 
budget issue. The President's proposed annual increases of $150 million 
would fall short of the roughly $400 million that would be needed to 
keep up with expected inflation of about 5 to 7 percent. The impact on 
Federal outlays, State-local revenues, and service levels depends on 
the combination of revenue sharing with all other grant programs. 
Federal outlays and State-local revenues can be set at desired levels 
by various mixes of different forms of aid. Increases or decreases in 
Federal control of State-local spending can be accomplished by shift- 
ing funds from general revenue sharing to more restricted forms of 
grants, or vice versa. Thus, funding levels for general revenue sharing 
inevitably form only one element in an overall strategy of how much 
aid, for what purposes, with what controls. 

Since general revenue sharing funds are generally unrestricted as 
to use and are small compared to total spending by recipient govern- 
ments, it is not possible to determine the actual effect of the program 
on State-local spending allocation among functions, recipients, etc. 
The reported uses of the funds may or may not correspond to the 
actual incremental spending allocations induced by the program. 
Thus, while the impact on jurisdictions is generally known, the 
impacts on distribution of income and services among people are 
not known. 

Other issues, less directly related to the size of the 1977 Federal 
budget include (1) restructuring the allocation formula, e.g., to in- 
crease funding to cities where poverty or tax effort is high, (2) 
strengthening prohibitions concerning discrimination, and (3) changing 
the duration of forward entitlement. 


Current Proposals 

In the past year, Congress has considered several strategies to com- 
bat recession which involve State and local governments. Congress 
increased funding for Title VI of the Comprehensive Employment 
Training Act providing a total of 310,000 public service jobs. In ad- 
dition, it passed the Public Works Employment (PWE) Act of 1975 
incorporating two additional antirecession programs: Title I au- 
thorized $2.5 billion for a program of accelerated public works. Title 
II represented a new approach; Congress authorized an antirecession 
grant program which would distribute funds whenever national un- 
employment exceeds 6 percent. Recipients would be limited to gov- 
ernments hardest hit by recession. The funds could be used to insure 
the maintenance of basic public services. 

The Public Works Employment bill was vetoed by President Ford 
in February. The House voted to override but the Senate vote fell 
short of the required two-thirds. In his veto message, the President 


reserved most of his criticism for the Title I construction program r 
arguing that the peak impact would come too late — in 1977 or 1978 — 
adding stimulus to the economy at a point when recover}' was well 
underway. He expressed support for the idea of antirecession as- 
sistance, however, and recommended consideration of the Brown- 
Griffin Supplemental Community Development Emplovment As- 
sistance Act of 1976 (H.R. 11860; S. 2986). 

The three approaches, accelerated public works (Title I of PWE), 
antirecession grants (Title II of PWE), and supplemental community 
development (Brown- Griffin), are contrasted in Table 5 and high- 
lighted below. 


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— Triggers: Both antirecession grants and Brown-Griffin are 
triggered by national unemployment. The antirecession grants 
had a threshold of 6 percent unemployment; Brown-Griffin 
7 percent. Accelerated public works would have become 
effective immediately upon appropriation of funds. 

— Funding levels: Brown- Griffin authorizes funding at a substan- 
tially lower level than did the vetoed Public Works Employ- 
ment bill. Were the unemployment rate to remain constant 
at 7.5 percent through the end of fiscal year 1977, over $4 
billion would have been made available for obligation by the 
Public Works Employment bill ($2.5 billion for accelerated 
public works; $1.6 billion for antirecession assistance); Brown- 
Griffin would authorize only $375 million under the same 

— Who is eligible: The public Works Emplo3 r ment bill qualifies 
more jursidictions for funding than does Bro^m-Griffin. Funds 
for accelerated public works (Title I of the PWE bill) are 
distributed on a project basis; antirecession grants (Title II 
of the PWE bill) and supplemental community development 
assistance (Brown- Griffin) are both distributed primarily by 
formula. Any State or general purpose local government 
with unemployment higher than 4.5 percent is eligible for 
Title II funding; only local governments with unemployment 
above 8 percent can receive supplemental community develop- 
ment assistance. 

— Use of assistance: Antirecession grants can be used to purchase 
materials and labor necessary for the maintenance of public 
services. Brown- Griffin funds can be used for any activit.y — 
construction or otherwise — consistent with the community's 
development plan. Accelerated public works would, of course, 
be limited to construction activity. 

Impacts of the Options 

There are two separate though complementary goals to be achieved 
by programs offering countercyclical assistance; to stimulate economic 
recovery and to moderate the negative impact of recession on State 
and local government services. 

To be effective a program must create new demand and stimulate 
jobs with expenditures in the right amount, in the right places, at 
the right time. In a recessionary period, accelerated public works 
and supplemental funding for community development will almost 
certainly create new jobs since a high proportion of community 
development and major construction money comes from the Federal 
Government and more money will mean more activity. Antirecession 
grants are likely to be used to fund services previously provided, and 
will have a stimulative effect if they prevent a community from 
having to raise taxes or cut services in response to declining revenues. 

For the greatest impact, stimulus should be applied as soon as 
there is clear evidence of recession. Once recovery is well underway, 
stimulative programs may have an inflationary impact as they require 
resources which are becoming scarce. Given the present stage of 


recovery, the greatest difficulty with respect to timing is likely to 
arise from a public works approach, which often requires substantial 
start-up time and lengtlvv spend out. However, accelerated public 
works can be effective in a short time if administration is efficient 
and emphasis is placed on smaller projects. The Brown-Griffin bill 
may have similar timing difficulties as well, because (if the experience 
of the existing community development block grant program is a 
relevant guide), a substantial proportion of the funds may be used for 
( 'on-truction activities. However, repair and renovation projects are 
possible alternative uses. Such projects could be completed fairly 
rapidly. Since antirecession grants are to be used to fund ongoing 
services, their impact should be felt relatively quickly. 

A one percentage point increase in the national unemployment rate 
creates a gap between declining State-local revenues and increasing 
state-local service demands of $6 billion. At 7.5 percent unemploy- 
ment, the budgets of State and local governments would be adversely 
affected by $21 billion compared to what they would be if unemploy- 
ment were only 4 percent. That is, these governments in the aggregate 
would have to raise taxes, reduce spending, or drawdown previously 
accumulated surpluses by $21 billion. Thus, $6 billion per percentage 
point of extra unemployment would be the amount of Federal assist- 
ance required to hold these governments fully harmless from the 
effects of recession. To be most efficient, this money would be carefully 
allocated among individual jurisdicticns to recognize the very different 
fiscal positions of different State and local governments. 


Program Summary 

The LEAA program begun in 1969, expires at the end of fiscal 
year 1976. Outlays were $0.9 billion in 1975 and the current policy 
level for 1977 is $1.0 billion. The President has proposed to renew 
the program but at a reduced budget authority of $0.7 billion in 1977. 

LEAA grants account for approximately 1% percent of total Federal 
aid to State and local governments, and 5 percent of total State-local 
outlays on law enforcement. Thus even major changes in the program 
would have only small effects on the Federal aid picture, general 
economic conditions, or the fiscal positions of recipient governments. 
The more important impacts are in terms of the details of State and 
local law enforcement activit} 7 . These impacts have been the subject 
of considerable controversy. 

Issues and Options 

Much of the controversy about LEAA relates to what extent the 
program should simply provide financial assistance to local law 
enforcement agencies (or, more widely, criminal justice systems) as 
opposed to retaining more Federal control of funds to insure that 
they are spent on research, demonstration, and other projects ex- 
pected to produce innovations in law enforcement practices. A block 
grant approach is more appropriate to the former, while more federally 
controlled projects would offer a greater chance of achieving the latter, 
for a given amount of money. A second issue has been the focus on 


law enforcement versus the entire criminal justice system; LEAA 
has been moving away from an initial heavy concentration on law 
enforcement toward somewhat greater emphasis on other parts of 
the criminal justice system, including assistance to States for com- 
prehensive systemwide planning. Options for FY 1977 include elimi- 
nation of LEAA, renewal without change at current or reduced 
funding levels, or targetting of resources on development of innovative 
approaches to improved crimiDal justice. 


Program Summary 

This tax expenditure will cost the Treasury an estimated $4.5 
billion in 1977. The exclusion provides direct assistance to State and 
local governments by reducing the interest rates they pay. However 
some bond purchasers receive more interest than needed to induce 
them to buy the bonds; an estimated 25 percent of the benefits of the 
Federal tax expenditure is diverted in this manner from State and 
local governments. 

Federal Subsidy of Taxable Bonds 

State and local governments could be given the option of issuing 
taxable bonds on which a portion of the interest costs would be paid 
by the Federal Government. CBO estimates based on a 40-percent 
subsidy indicate that initial year gross subsidy costs could be as 
high as $1.4 billion. Increased revenues would offset the subsidy cost 
to the extent that investors substitute taxable investments for current 
holdings of tax-free municipals. The offset could be as high or even 
higher than the amount of the subsidy, but the actual response is 
very difficult to predict and would depend on the availability of 
alternative tax shelters. Subsidy costs and any revenue offsets would 
rise over time, as more subsidized taxable bonds were issued. 

Establish Federal Guarantees or Insurance, A Development 
Bank or other Pooling Mechanism 

All of these options move toward Federal assumption of risk. A 
public authority could raise funds by selling taxable bonds at market 
interest rates and then lend to State and local governments. If a 
subsidy were desired, the re-lending could be at a lower interest rate 
with the difference met through Congressional appropriation. A 
variant of this approach would have the Federal Government assist 
States in establishing development banks through insurance or direct 
subsidy; others are Federal guarantees or insurance. A development 
bank or other pooling mechanism would especially increase the 
marketability of bonds issued by small jurisdictions. All of these 
options would reduce or eliminate the discipline now imposed on 
state and local governments by the need to market their own bonds. 
Replacing this discipline by s( me sort of Federal review, differential 
insurance premiums, or other mechanisms is possible in theory but 
poses potentia ly thorny political and administrative problems. 


Other Options 

Repeal of the exclusion could also be compensated by increased 
general revenue sharing, and/or by grants for capital expenditures. 

Most of the other kinds of assistance would increase Federal control, 
at least to some extent, and many of them might increase State-local 
uncertainty as to future benefits. 


The Overall Picture 

As already noted, the President's 1977 budget would reduce Federal 
spending as well as Federal control in categorical programs. Budget- 
wide, the President's proposals for grants are $60.5 billion, which is 
13 percent below current policy budget estimates for the year. Most 
of the cuts come in categorical grants in human resource programs. 
For all human resource programs combined (functions 500, 550, 600, 
and 700), the President's proposed grants to State and local govern- 
ments are $7.3 billion or 18 percent below current policy. For general 
assistance (function 850) his proposals are $0.1 billion, or 1 percent 
below, and for other areas his proposals are $1.9 billion, or 9 percent, 
below current policy. 

It is very hard to predict the net distributional impact of these cuts 
on individual States and local jurisdictions or the responses of State- 
local governments to such cuts. Many recipient governments may be 
able to continue current service levels, some perhaps even without tax 
rate increases. Others will have to cut assistance and/or increase tax 
rates. The ultimate impacts on State-local fiscal situations, program 
beneficiaries, and taxpayers will vary considerably among jurisdictions. 

The President's proposals would reduce Federal control over State 
and local programs. Consolidation of categorical programs into block 
grants in health, education, child nutrition, and social services will 
permit States more freedom in allocating their own and Federal funds 
according to their own priorities. Elimination of matching require- 
ments in many programs will further increase State-local flexibility in 
how much is spent in each area. As with the other options, the 
President's proposals for grant consolidations can be dealt with 
separately from his proposed funding levels. 

In health, child nutrition, and education, the President has proposed 
major structural changes: Most or all of the categorical programs in 
these areas are proposed for replacement by block grants. Table 6 
summarizes the proposals. 


Federal aid is just under $10 billion per year. This is 40 percent of 
State-local outlays for health, and about 8 percent of all public and 
private spending in the area. The President proposes to reduce 
outlays for Federal grants in the health function by $1.7 billion, or 
about 17 percent, in fiscal 1977 as compared with current policy 
levels. A key element of the President's proposal is the consolidation 
of Medicaid, the developmental disabilities program for retarded 
persons, and 14 other health programs in a single block grant to 





Maternal and child health 
Community health center 
Family planning 
Community mental health 
Alcohol abuse 
Other programs 

Total 9.6 11.0 10.0 -1.0 

Child Nutrition: 
School lunches 
Commodity distribution 
School breakfast 
Special milk 
Other programs 

Total 2.7 3.2 2.0 -1.2 

Education : 

Vocational education 
Adult education 
Library resources 
Other programs 

Total 3.6 3.8 3.3 -.5 

States. The only major Federal health programs currently aiding 
States and localities that would not be included in the new block 
grant are drug abuse, health maintenance organizations, professional 
standards review organizations and the National Health Service Corps. 
Outlays for the block grant would be $1.5 billion less than the amount 
necessary to maintain current policy for the individual programs they 
would replace. The remaining $0.2 billion in reductions is mostly 
for health manpower programs. 

Under the President's proposals, services would be concentrated 
on low-income populations, thereby providing more assistance for 
some of the neediest people and achieving greater equity among the 
different State programs. The cuts proposed by the President would be 
concentrated in States now supplying high levels of services. These 
States would face a significant fiscal squeeze, because the cuts amount 
to about 7 percent nationwide of total State-local spending on health. 
Thus, States where services are now high would either have to cut back 
services or increase taxes under the new block grant allocation pro- 
cedures. In addition, with the elimination of mandatory cost sharing 
under the President's proposed plan, the total amount of public 

[In billions of dollars] 

year 1976 

Fiscal year 1977 


Current President's Difference 
policy request 


sector funding for health care services is likely to be reduced. The 
programs most likely to be reduced are those now emphasized in the 
Federal grants, such as out-patient services, community health care, 
and home health care and screening programs. 


The President's proposals would reduce Federal outlays for ele- 
mentary and secondary education by $1.6 billion below current 
policy levels, and release programmatic controls over 27 special- 
client programs by consolidating them into a block grant. Most of the 
President's cuts are concentrated in programs for the economically 
disadvantaged and students with special needs. 

The Federal share of public school expenditures increased during 
the early 1960s but has remained stable since then at around 8 percent 
of the total. The State-local split of the remaining 92 percent differs 
considerably for State to State, 

The combined effect of the President's funding and consolidation 
requests would depend on State-local structures and responses; the 
effects will surely vary by State and by locality. Efficiencies due to the 
added flexibility in the President's consolidation proposal may offset 
part or all of the difference in funding from current service levels. 
States and local governments may absorb part or all of the added 
costs of maintaining current service levels through increased taxes, 
available revenues, or shifts in program priorities. The overall fiscal 
impact would be small, because the proposed cuts are only around 1 
percent of aggregate State-local spending for education. 

Federal education programs presently attempt to focus on econom- 
ically disadvantaged groups and those with special education needs, 
such as the handicapped and bilingual. Negative effects on these 
groups may be less where the groups are highly concentrated and well 
organized (e.g., Chieanos in the Southwest, the handicapped in 
Maryland and Massachusetts) or where exemplary State programs 
currently exist (e.g., compensatory education programs in Michigan 
and California, and programs for the handicapped in Washington, 
New Jersey, Michigan, California, North Carolina, and Massachu- 
setts). However, where program efforts have been exclusively Federal 
or where affected subpopulations are dispersed or poorly organized, 
the current beneficiaries are more likely to be adversely affected. 

Child Nutrition 

There are now 15 child nutrition programs which will cost the 
Federal Government $2.7 billion in fiscal 1976. The President proposes 
to consolidate all of these programs under a Child Nutrition Reform 
Act (block grant), at a funding level of $2.0 billion for fiscal 1977 com- 
pared to a current policy estimate of $3.2 billion. Local matching 
requirements are to be eliminated. 

In fisc al 1976, it is estimated that over $4.9 billion will be spent by 
Federal, State, local, and private sources for the purpose of main- 
taining the nation'-- child nutrition programs. 

Of tin' total, 54 percent will be provided by the Inderal Govern- 
ment, 20 percent by State and local sources, and the remainder by 
recipient children. 


Under the President's proposal, non-needy students would be most 
affected by the proposed block grant. Approximately 15 million 
students (about 30 percent of the national school enrollment) could 
be affected. If Federal funds were no longer available to fund lunches 
for non-needy students, school food service systems could continue 
to serve them either at a higher meal charge to the student, or with 
greater state and local contributions, or a combination of both. If the 
entire additional cost were borne by the non-needy student, meal 
charges would increase by approximately 25 cents (up from an average 
of 50 cents presently), and the cost of a half-pint of milk would in- 
crease by about 5 to 7 cents (up from 6 cents presently). The total 
cost to be borne, then, to make up this price increase would be approxi- 
mately $750 million. (The remaining $450 million in reduction from the 
current policy level results from caseload growth expected under cur- 
rent law for which there would be no new funds.) 

Rural elementary school children from families above the poverty 
line and primarily from the Southeast, Southwest, and Midwest would 
most likely be adversely affected by the block grant. Infants (under 
age 1) now receiving benefits in the special supplemental feeding 
program would be excluded from being served under the grant monies. 

V. Conclusion 

Over the last 2 decades, total government outlays have increased 
steadily as a proportion of GNP, due principally to the growth of 
State and local government expenditures. A significant source of sup- 
port for increased State and local spending has been increased Federal 
grants in aid, which have risen as a proportion of both Federal outlays 
and State and local outlays. At the same time, Federal control over 
State and local uses of grant funds has declined, through moves to 
general revenue sharing and block grants. A basic question underlying 
this year's budget decisions is— "Should these trends continue?" 

The current recession complicates this year's decisions. Grant in- 
creases will help state and local governments over a difficult period 
when their revenues are cyclically low and their service demands 
cyclically high. Grant reductions will in most cases disrupt strained 
State and local budgets and prompt service cutbacks and tax increases 
which will work a hardship on people in need and undermine national 
economic recovery. However, directions can be set which will allow 
fiscal relations to develop along desired future paths. Antirecession 
grants provide a flexible tool to address the current needs of State and 
local governments and national economic recovery without forciug 
long-run Federal-State-local fiscal relationships down any particular 

For the longer-run, a number of structural directions are possible. 
One which has been recommended by the Labor and Public Welfare 
Committee involves grant increases above current policy level — 
principally for education and jobs — without major change in program 
structure. Another is to follow the President's conceptual approach 
and (1) renew revenue sharing with multiple year funding, (2) 
extend the Law Enforcement Assistance Administration block grant, 
and (3) consolidate existing categorical programs into four new block 
grants in the education, health, child nutrition, and social services 


areas. This will continue the trend toward less Federal control, which 
should result in program efficiencies and a reduced or stabilized need 
for Federal aid. Spending options corresponding to this choice concern 
how much saving over current growth trends is possible and how 
quickly it can be realized. The major options include: 

— Maintain expenditures at current policy level for fiscal 1977 and 
aim to stabilize the dollar amount or reduce the rate of growth 
of Federal grants over the period 1978-80 as a result of 

— Accept the President's proposal of $9.3 billion in cutbacks from 
current policy, which will reduce the dollar amount of fiscal 
year 1977 Federal grants slightly below their estimated fiscal 
year 1976 level. 

— Make selective consolidations this year, but not as broad as 
proposed by the President, and selective grant reductions or 
stabilizations where efficiencies can be achieved or functions 

A third possible direction is toward considerably reduced Federal 
grants to State and local governments, continued Federal control 
over use of the remaining funds, and federalization of key national 
services such as welfare and health finance, which will eliminate the 
need for sizable State and local matching contributions. This ap- 
proach could result in a higher or a lower effective level of support 
for State and local governments depending on the relative size of 
reductions in State and local financial obligations and Federal grant 
assistance. Decisions this year which correspond to this direction 
include — 

— adoption of renewed general revenue sharing with provision for 

less than 5-year funding; 
— elimination of LEAA block grant, with limited funding retained 

for specific innovative approaches to improve criminal justice; 


— commitment to key national service programs, such as welfare 
reform and health insurance, to be bought in the future with 
the proceeds of economic growth and reduced general support 
for State and local governments. 

Under all of the above possibilities, properly scaled antirecession 
grants are appropriate to address current State-local fiscal needs 
without making any unwanted permanent funding commitments. 

This year's decisions can serve both the short-run and the long-run. 
If one wishes to achieve long-run goals of stabilized or reduced size of 
government or savings from grant consolidation, there is no need to 
cutback sharply on grants and disrupt State and local fiscal positions 
now in order to do so. At the same time, if one wishes to move in a 
new long-run direction, there is no need to sacrifice this year's im- 
portant opportunity to do so on account of concern for the present 
strained condition of State and local budgets. 




This paper was prepared to provide background for the delibera- 
tions of the Senate Budget Committee prior to its markup of the 
First Concurrent Resolution on the Budget for Fiscal Year 1977. 

The report was prepared by James R. Storey of the Senate Budget 
Committee staff. Franklin Jones, Senator Domenici's staff representa- 
tive on the Committee staff, made a major contribution to the report. 
Also contributing to the report were Becky Beauregard and Karen 
Schubeck of the Committee staff and Jack Burby, an editorial con- 
sultant. Numerous staff of the Congressional Budget Office developed 
background materials from which much of the factual material in the 
report w as drawn. 

Edmund S. Muskie, 



72-678—76 7 


I. Summary 

Over one-third of Federal outlays are devoted to the replacement of 
lost income or income supplementation for Americans who are retired, 
disabled, or the survivors of deceased breadwinners. Nearly one-third 
of all Federal revenues are derived from the special taxes levied to 
fund these retirement systems. And nearly half the yearly growth in 
the current services budget results from rising numbers of bene- 
ficiaries entitled under these programs, from automatic cost-of-living 
increases for these beneficiaries, aud from higher real benefits caused by 
a rising wage base. 

Estimated outlays for retirement programs in fiscal 1977 under 
current law will total $150 billion, about $87 billion of which is for 
social security and railroad retirement benefits. Another $29 billion 
goes for Medicare and the Federal share of that part of Medicaid 
that aids the aged and disabled. Civil service and military retirement 
account for $18 billion, and veterans disability compensation and 
pension benefits total $8 billion. Welfare programs for the aged and 
disabled will pay out $6 billion. 

A number of policy issues, particularly the issue of social security 
financing, are important in the context of the 1977 budget and the 
period of 1977 to 1981. However, these issues must be considered in a 
broader context for two reasons: (1) the long-range projections for 
social security show a large deficit in the 21st century, due in almost 
equal measure to adverse demographic trends and to the "coupling" 
problem; 1 and (2) many beneficiaries under one retirement program 
draw benefits from others concurrently, so that individual program 
issues necessarily interact with each other. Thus, alternative ap- 
proaches to short-run problems must allow for their likely impact on 
long-range financing problems and for their effects on all related bene- 
fits considered as a single system. The following paragraphs describe 
the major issues of immediate interest this year. 

1 "Coupling" refers to a problem in the way social security benefits are adjusted 
for inflation. The adjustment affects not only current benefit payments but also 
future benefits for people now working. This results in their being overcom- 
ponsated for inflation. 




In May 1975, the Social Security Trustees reported an anticipated 
deficit in the trust fund 2 by the early 1980's. This forecast was based 
on a rapid rise in benefits responding to double-digit inflation, and 
shortfall in revenues due to the recession. Since that report, official 
but unpublished projections are more optimistic. They show trust 
fund reserves declining to $30 billion (about 3 months worth of bene- 
fits) in fiscal 1981. A projection by CBO has the reserves bottoming 
out at $28 billicn in fiscal 1980 and rising in the next year. 3 

Although the outlook is now more optimistic for the short-run, the 
President has proposed raising the tax rate by 0.3 percent each for 
employee and employer (from 5.85 percent of covered wages to 6.15 
percent). This would raise fiscal 1977 revenues by $3.3 billion ($4.4 
billion for a full year). Reserves in fiscal 1980 would amount to 4 or 5 
months' worth of benefits. This proposal has been criticized for three 
reasons: (1) it will add to the cost of goods and services, thereby 
contributing to inflation ; (2) it reduces the proposed fiscal stimulus of 
further income tax cuts; and (3) it would combine an increase in a 
regressive tax with a proposal to reduce the progressive income tax. 

There are a number of alternatives available to Congress including 
the following : 

(1) Action could be delayed for a year or two if the financial situation 
permits, so that appropriate action for the short-run can be considered 
and developed as an integral part of the long-run solution. A delay 
would cost the fund between $1.5 and $5 billion for each year of delay, 
to be recovered over the actuarial period of 75 years. 

(2) Limited changes could be made now in the tax and/or benefit 
structure which might be deemed an appropriate part of any remedy 
for the long-range problem. This would reduce the pressure to develop 
an integrated solution quickly. Alternatives for limited changes 
include : 

(a) Increasing the wage base, which redistributes the tax burden 
toward those persons who earn wages higher than the current 
maximum of $15,300. It could be argued that these individuals 
could most easily bear the additional burden, which would be at 
no greater rate than that paid by lower wage earners, and on no 
greater portion of their wages. On the other hand, the higher wage 
base would generate higher benefits in the future, although not by 
enough to increase the longrun deficit. Consideration also must 
be given to the potential adverse effect on private investment 
markets and on private capital formation. 

(b) Eliminating the ceiling on the wage base for the employer only 
is a possible long-run remedy because it does not result in higher 
employee benefits in the future. However, it would be a sharp 
tax increase for employers, which might be passed on to workers 
through smaller wage increases or in shifts between capital and 

(c) Use of part of the Medicare payroll tax for cash benefits was 

3 This discussion refers to a combination of two trust funds: the old-age and 
survivors insurance trust fund; and the disability insurance trust fund. Medicare 
is financed through two other trust funds: the hospital insurance trust fund; and 
the supplemental medical insurance trust fund. 

3 Congressional^ Budget Office "Five- Year Budget Projections" report pre- 
sented in testimony before the House Ways and Means Subcommittee on Social 
Security on February 3, 1976: 


proposed by the 1975 Social Security Advisory Council. Medicare 
does not face a shortrun deficit, but advocates of expanded health 
insurance oppose such a transfer of funds. 

(d) Some selective benefit reductions, such as those proposed in 
the President's budget, can be made, but large savings cannot be 
realized in the short run without the risk of creating hardship 
among current beneficiaries or those about to retire. 

(3) A general fund grant can be made to the fund. It would be neutral 
in its interaction with remedies for the long-term deficit, and it would 
not result in permanent benefit increases. However, a temporary 
Federal transfer could become a permanent habit. If it became 
permanent, it would constitute a basic change in the self -financing 
structure of the social security program. 4 

(4) Congress could provide authorization for the manager of the fund to 
borrow from the Treasury in the event that the fund exhausted its 
reserves. Since such borrowing would be used only in the event of 
actual depletion, it would permit the system to retain its self-financing 
structure and would not require as large a reserve fund. 

(5) A new tax could be levied on energy or another commodity, with 
the funds earmarked for social security. Such a proposal aims at 
replenishing the social security funds with a socially useful tax (e.g., a 
tax on energy to encourage conservation) . 


The President has proposed protection against catastrophic health 
care costs for services covered under Medicare. No beneficiary would 
have to pay more than $500 in yearly out-of-pocket costs for covered 
hospital services, or more than $250 for covered physician's services. 
The cost of such protection ($430 million) would be more than offset 
by other proposals to increase beneficiary cost-sharing and to limit 
increases in fees reimbursable under Medicare. 

A plan to protect all Americans against catastrophic illness has been 
proposed by Senator Long (S. 2470). His bill would also federalize and 
reform Medicaid. The total first-year net additional cost of the bill 
would be about $10 billion. 


When cost-of-living adjustments are applied to benefits under the 
civil service and military retirement systems, an extra 1 percent is 
added to the consumer price index increase to make up for the time 
lag between the effects of inflation and the adjustments to retirees' 
checks. But this extra 1-percent factor overcompensates retirees for 
inflation over the long run, and the President has proposed a repeal 
of this provision. 

The President's proposal would save $182 million in fiscal 1977; by 
the year 2000, this saving will grow to $6 billion a year. Alternative 
measures may be proposed in Congress, such as dropping the 1 -percent 
add-on but making a lumpsum adjustment each time a retiree gets a 
cost-of-living increase. While this would save money in the long run, 
near-term outlays would be increased. 

4 Some advocates have proposed a permanent general fund contribution equal 
to the employees' contribution, or one-third of total funding. Congressman 
Burke, Chairman of the House Subcommittee on Social Security, favors this 


There is also interest in basic reform of the military retirement 
system. One major issue is whether or not the system should be made 
contributory like the non-military programs. 


The Senate has passed a bill to reform the VA pension program 
(S. 2635). The House is considering amendments to the SSI program 
(H.R. 8911 and 8912) and the black lung benefits program (H.R. 
10760). The first-full year cost of these bills would be almost $2 
billion. The House is also considering a liberalization of the retirement 
income credit, which would reduce annual revenues by $340 million. 

II. Importance of Retirement and Disability Programs to Fiscal 


Budget Impact of Retirement and Disability Benefits 

The Federal role in provision of income to the retired, disabled, and 
survivors accounts for 35 percent of all Federal outlays, 37 percent of 
the growth in outlays from 1975 to 1976, and 45 percent of the expected 
growth in a projected budget level that would maintain current policv 
from 1976 to 1977. The trust fund revenues earmarked for these 
programs amount to 31 percent of all Federal revenues. Thus, future 
policy for retirement programs will have a major impact on future 
budget options, both on expenditures and revenue collections. 

According to the President's budget, fiscal 1976 outlays under 
current law for retirement and disability programs will total $131 
billion, and earmarked revenues will amount to $105 billion. The 
fiscal 1977 figures are $150 billion in outlays and $123 billion in 
revenues. The detail by program is as follows : 

[In billions of dollars] 

Fiscal year 1976 Fiscal year 1977 

Program Trust Trust 

fund Outlays fund Outlays 
revenues 1 revenues 1 

Social security (OASDI) 

Medicare (HI and SMI) 

Railroad retirement 

Coal miners' benefits 

Federal employee retirement 

Military retirement 

SSI 2 

Medicaid (aged, blind and disabled 

portion) 2 

Veterans' compensation 

Veterans' pensions 

Food stamps (aged, blind and disabled 



09. 8 72. 7 80. 83. 6 

18.5 17.5 23.0 21.9 

3.5 3.4 3.7 3.7 

1.0 .9 

13.0 8.6 15.9 9.9 

7. 4 8. 5 

5. 5 5. 9 

6.2 7.0 

5. 5. 2 

3. 2. 8 

. 3 . 3 

104. 8 130. 6 122. 6 149. 7 

1 Programs with no revenues shown are funded from general revenues. Those 
with trust fund revenues also receive some transfers from general revenues as set 
forth in the particular statutes involved. 

2 These Federal outlays are matched or supplemented by additional outlays of 
State and local governments. 


Future Trends 

Retirement benefits will continue to be a growing sector of the 
Federal budget, assuming a continuation of current law. 

There are three major factors accounting for growth in these pro- 
grams. First, except for veterans' benefits, these programs are all 
adjusted automatically for inflation. Such adjustments account for 
62 percent of the growth in outlays from 1975 to 1976. 

A second major growth factor is a rising beneficiary population. 
In addition to the general population increase, program beneficiaries 
rise due to past changes in law, or because of such factors as a growth 
in the number of Federal civilian and military employees in prior 
decades producing more Federal retirees and veterans in this and 
future decades. Increasing numbers of beneficiaries accounted for 
19 percent of growth in spending on retirement benefits from 1975 
to 1976. 

A third factor in growth is a rising real value of benefits. New 
retirees have their benefits based on more recent wage histories, 
reflecting higher wage levels than earlier retirees. Hence, their benefits 
are higher as well. Real growth in benefit levels accounted for the 
remaining 19 percent in the 1976 outlay increase over 1975. 

The Congressional Budget Office (CBO) has made a 5-year projec- 
tion of program outlays based on the Second Concurrent Budget 
Resolution for FY 1976. The projections indicate a 69-percent increase 
in outlays from 1976 to 1981 (see Table 1). 


[In billions of dollars] 

Estimate Path B projections 


1975 1976 TQ 1977 1978 1979 1980 1981 

Social security (OASDI)_ 



72. 7 

19. 9 

84. 5 

93. 5 







Medicare (HI, SMI).__ 



17. 5 

4. 8 

20. 5 

23. 7 






Railroad retirement 




. 9 

3. 7 

3. 8 






Coal miners' benefits 



. 4 

1. 3 








Civil service retirement. 


8. 6 


10. 2 

11. 8 






Militarjr retirement 



7. 4 


8. 6 

9. 7 










5. 5 

1. 5 

6. 2 

6. 9 







Medicaid (aged, blind 

and disabled part) 



6. 2 

1. 6 

7. 1 








VA compensation.- 




i. 3 

5. 4 

5. 7 







VA pensions 




. 8 

3. 1 








Food stamps (aged, 

blind and disabled 




. 1 

. 3 








130. 6 

35. 7 

150. 9 

168. 1 







Source: Unpublished tabulations, Congressional Budget Office. 


At the request of the Senate Budget Committee, the CBO projected 
income transfer payments to the year 2000 to determine if any major 
shift should be expected in the proportion of gross national product 
transferred through Federal income transfer programs. The report 3 
indicates that, assuming no major changes in current law, the current 
share of GNP (9.3 percent) devoted to income transfers will not 
change greatly over the rest of this century. Those contributory 
programs providing retirement benefits will rise relatively (from 
6.8 percent to about 8 percent of GNP), but this growth would be 
offset by a decline in the noncontributory programs, since the latter 
programs count increased benefits from other programs against 
recipient income (see Table 2). 

The retirement in the 21st century of people born after World 
War II will escalate the growth of social security. For example, in 
the year 2020, social security benefits will grow to $472 billion 
under current law, or 6.6 percent of GNP, compared to $179 billion 
and 4.9 percent in 2000. If "decoupled" to eliminate over-compensa- 
tion for inflation, the figure in 2020 would be $356 billion, or 5.0 
percent of GNP. Thus, without decoupling, there will be substantial 
relative growth in social security benefits in the next century. 

Tax Expenditures 

A number of tax expenditures are relevant to the retired and aged 
population. These provisions of tax law are listed below, together 
with estimates of the fiscal 1976 revenue losses associated with them: 

_ _ Fiscal 197 6 cost 1 

Tax Expenditure: (millions) 

Exclusion of military disability pensions $85 

Disability insurance benefits exclusion 280 

OASI benefits for the aged exclusion 2, 940 

Benefits for dependents and survivors exclusion 480 

Exclusion of railroad retirement system benefits 180 

Employer plans: exclusion of pension contributions and earnings 5, 740 

Plans for the self-employed and others: exclusion of pension con- 
tributions 710 

Exclusion of capital gains on house sales if over 65 10 

Additional exemption if over 65 1, 250 

Retirement income credit 70 

Exclusion of veterans' disability compensation 550 

Exclusion of veterans' pensions 35 

Exclusion of capital gains at death 4, 550 

Exclusion of interest on life insurance savings 1, 820 

Exclusion of employer contribution to medical insurance premiums 

and medical care 3, 665 

Deduction for medical care expenses 2, 020 

1 Estimated by the Treasury Department and the Joint Committee on Internal Revenue Taxation. 

8 "Growth of Government Spending for Income Assistance : A Matter of Choice," Senate 

Budget Committee Print, Dec. 3, 1975. 

















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of lost revenues is clear. 

III. Relationships Among Retirement and Disability Programs 

Trends for individual programs cannot be considered in a vacuum, 
since beneficiaries often receive benefits from more than one program. 
A policy decision on a social security matter, for example, will affect 
millions of welfare recipients and many people who also receive 
retirement checks under other systems. 

Figures 1 and 2 illustrate graphically the relationship between the 
social security beneficiary group and those receiving SSI and VA 
pension benefits. Of the social security beneficiaries over age 65, 16 
percent are also in one of the two assistance programs. About three- 
fourths of SSI recipients and over 80 percent of VA pensioners also 
receive social security benefits. 

Social security CCASDO 

Fig. 1. — Overlaps in beneficiary groups, fiscal year 1975 


Social security (QASOO 

Ocas tnan recipient*) 

Fig. 2. — Overlaps in beneficiaries age 65 and over, fiscal year 1975 

Other program overlaps of interest in considering major policy 
issues include the following: 

(1) Medicare, an adjunct to social security, and Medicaid, a 
supplement to welfare aid, overlap each other, with about 17 
percent of Medicaid recipients also eligible for Medicare benefits, 
although in some cases such dual coverage is supplementary. 

(2) About 38 percent of civil service retirees, and virtually 
all military retirees, are entitled to social security benefits — 2.5 
percent of social security beneficiaries receiving the minimum 
benefit are retired civil servants. 

(3) Most SSI recipients are eligible for food stamps, although 
only about 50 percent actually participate in the program. 

(4) About 36 percent of food stamp recipients receive benefits 
from social security as well. 

Thus, legislative changes in any one of these programs may affect 
the recipients of several other programs. Retirement policy should 
be considered for all of these related programs as a system in order 
to avoid unanticipated consequences detrimental to a beneficiary 
group or a particular policy goal. 


IV. Major Policy Issues 


The Background 

Fund deficits 

Benefit payments under the social security old-age and survivors 
and disability insurance programs (OASDI) will exceed receipts of 
the related trust funds by some $2.9 billion in fiscal 1976 and by about 
$1.7 billion in the Transition Quarter. Unless legislative action is 
taken, this deficit will exceed $5 billion in fiscal 1977 under either the 
economic assumptions used in the President's budget or the Path B 
assumptions used in CBO's "Five- Year Budget Projections, Fiscal 
Years 1977-81." Predictions of the extent to which trust fund reserves 
will be reduced by deficits in later years depend upon the economic 
assumptions used. The CBO projection shows reserves dropping to 
$28 billion in 1980 (down from $48 billion in 1975) but rising again in 
1981. 1 


Historically, receipts from payroll taxes for OASDI have exceeded 
benefit payments, except during economic downturns. The present 
excess of payments over receipts is the result of rapid inflation com- 
bined with a deep recession. Under the provisions of amendments to 
the Social Security Act which became effective in 1972, benefit pay- 
ments are automatically adjusted upward annually to compensate 
for increases in the cost of living. Prices rose rapidly in 1974 as the 
result of oil and food price increases and other inflationary forces. 
Simultaneously, business activity deteriorated with resultant unem- 
ployment and reductions in personal income. As a consequence of these 
events, total benefit payments increased rapidly as adjustments were 
made for price increases, while receipts of the OASDI trust funds, 
restricted by sluggish business activity, failed to reach anticipated 

Extent of the problem 

Table 3 illustrates the problem. 1 The report of the trustees of the 
social security fund issued in May 1975, forecast a more rapid decline 
in the reserves of the OASDI funds than that indicated by the Path B 
section of Table 3. The trustees predicted that, on the basis of more 
pessimistic economic assumptions, both the old-age and survivors 
insurance and the disability insurance funds would be depleted by 
about 1980 or 1981. 

1 Testimony of C. William Fischer, Assistant Director of the Congressional 
Budget Office, before the House Ways and Means Subsommittee on Social Se- 
curity, February 3, 1976. 


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Corrective action 

From 1961 to 1972, the ratio of reserves to annual benefits declined 
from 133 percent to 113 percent. Since then, it has declined sharply 
to 60 percent. If Congress determines that OASDI trust fund reserves 
should be maintained at higher levels because of the inherent un- 
certainties in economic projections, legislative action can be taken to 
increase receipts, selectively restrict benefit payments, or both. 

Possible Kevenue Solutions to the Short-Run Problem 


Alternative ways of increasing OASDI trust fund receipts include — ■ 

(1) increasing the tax rate applicable to the employee and the 

employer ; 

(2) increasing the tax rate applicable to the employer only; 

(3) increasing the maximum taxable earnings for both employees 

and employers; 

(4) increasing the maximum taxable earnings for the employer 


(5) a transfer of part of the Medicare payroll tax to the OASDI 

funds ; 

(6) a regular appropriation from general revenues in amounts 

sufficient to maintain the fund reserves at the desired level; 

(7) a one-time loan or grant from general revenue in an amount 

sufficient to insure that the fund reserves are maintained at 
the desired level; or 

(8) a levy of an excise tax on some activity or commodity such as 

energy with the proceeds earmarked for the OASDI funds. 

Present tax structure 

The present social security tax structure involves the following 
payroll tax rates applicable both to the employee and the employer 
on the first $15,300 in wages and salaries: 


OASI i 4. 375 

DI . 575 

Medicare . 900 

Total 5. 850 

Since the tax is paid by both the employee and the employer, the 
combined rate is 11.7 percent. 

The OASI and DI rates (4.95 percent combined on both employee 
and employer) are fixed by present law until the year 2011 when the 
combined rate will increase by 1 percent for both employee and 
employer. The taxable wage base is adjusted upward by the rise in 
average wages each time an adjustment in the benefit structure results 
from an increase in the cost of living. This automatic adjustment is 
expected to increase the wage base from the present $15,300 to 
$16,500 on January 1, 1977. 


Increase tax rates 

One of the alternatives for increasing revenues for the OASI 
program is to increase the tax rate applicable to both the employer 
and the employee. The President's 1977 fiscal year budget proposes a 
tax rate increase of 0.3 percent on both employers and employees 
effective January 1, 1977, raising the total social security payroll tax 
from 11.7 percent to 12.3 percent. According to the President's budget, 
the proposed rate increase would generate $3.3 billion in additional 
revenue in the nine months of the 1977 fiscal year for which it would 
be effective. Social security receipts would exceed outlays in fiscal 
years 1977 through 1981 if this rate increase and recommended benefit 
adjustments are adopted. The recommended benefit adjustments are 
discussed in the next section of this paper. 

A tax rate increase distributes the burden proportionately on all 
taxpayers who pay on less than the maximum taxable earnings, avoids 
borrowings or grants from outside sources and is not necessarily 
inconsistent with long-run remedies. On the other hand, payroll tax 
rates are already high (more than half the U.S. households pay more 
social security taxes than personal income taxes), and the burden falls 
relative^ harder on low-income salaried and wage employees. Half 
the payroll taxes collected in 1977 will relate to the wages of persons 
earning less than $7,500 a year. Others argue that the regressivity of 
the tax is more than compensated for by the relatively higher benefits 
enjoyed by low-income people upon retirement. 

Increase tax base 

Another alternative for increasing the OASDI revenues is to 
increase the amount of the wage or salary subject to tax. This would 
cause higher income people to bear more of the burden of financing 
the system. It is argued that the higher income individuals have 
greater ability to pay and, in any case, would be paying no greater 
portion of their income in social security taxes than do lower income 
people. On the other hand, since benefits are computed on the basis 
of average wages included in computing the tax, future benefits would 
be higher, although not by enough to increase the long-run deficit 
(to be discussed later). It is also argued that increasing the burden 
on higher income individuals could have an adverse effect on capital 

Applying increases to employer only 

Eliminating the ceiling on the wage base for purposes of computing 
the employers' tax, but retaining the ceiling for the employees' tax, 
could eliminate the objection that the higher wage base would create 
a long-run problem of increasing benefits. It would also be possible 
to increase the tax rate on the employer without increasing the em- 
ployee's rate. However, either of these approaches would sharply 
increase the employer's total tax, and the increase might eventually 
be passed on to employees through smaller or less frequent wage in- 
creases or through a shift to labor-saving machinery. 


Economic Implications of the Payroll Tax 

The payroll tax has a powerful impact on inflation and unemploy- 
ment. While it is thought that, in the long run, this tax is borne by 
wage earners, its short run effect is partly to raise prices. 

Half of the payroll tax is paid by employers. But employers treat 
this tax as a part of unit labor costs, and pass it on to consumers in 
the form of higher prices. Moreover, there is evidence that the tax 
is passed on with whatever markup is traditional in each industry. 
Thus, higher payroll taxes cause employers to raise prices, and this 
contributes to inflation in the short run. 

Since the tax removes purchasing power from private hands, it 
causes sales, and hence output, to fall just as any other tax increase 
would. But the reduction in sales is larger than would be the case for 
for an equivalent reduction in the income tax. This is because the pay- 
roll tax, in addition to reducing private funds, causes prices to rise, 
and the increase in prices reduces the purchasing power of the funds 
that remain in private hands. For this reason, it is felt that sales would 
fall more due to an increase in the emplo}~er pa3Toll tax than they would 
if the income tax were increased by an equivalent amount. 

The reduction in demand would remove some price pressure from 
private markets. This would offset part of the inflationary effect 
mentioned above. At present levels of unemployment, it is estimated 
that these two price effects might offset each other after about 5 
years. This happens in the case where the effect of the pa3rroll tax 
increase on unemployment is twice as strong per dollar as the effect 
of an increase in the income tax. Because of this sizable effect on 
demand, markets can cause prices to fall by as much as they are 
increased due to the effect of the payroll tax on labor costs. 

Since the payroll tax has adverse effects on unemployment and no 
beneficial effects on inflation, the other methods that are available for 
financing the Social Security System (described below) deserve 
consideration at this time. 

Use of medicare tax in OASDI trust funds 

The medicare program is funded in part by a 0.9 percent payroll 
tax on employees and employers. It is scheduled to rise to 1.1 percent 
on January 1, 1978. The medicare program does not face the short- 
run deficit problem that the cash benefit programs do. Even during the 
current recession, medicare trust fund reserves will rise by $3.9 
billion from 1976 to 1977. This situation prompted the 1975 Social 
Security Advisory Council to propose shifting part of the medicare 
tax to the OASDI trust funds. Advocates of expanded health insurance 
oppose this idea, wanting to retain these funds for health care financing. 

General revenue support or Treasury borrowing 

It would be possible to make up the short-term fund deficits by 
authorizing borrowing from the Treasury or annual appropriations 
from general revenues, or by making a one-time grant or loan from 
general revenues in an amount sufficient to cover the total of the 

72-678—76 8 


anticipated short-run deficits. Either of these methods would avoid 
permanent benefit increases and would make the source of the addi- 
tional fund support less regressive than would a rate increase. Federal 
funds could be justified as paying for certain welfare features of the 
system, such as the minimum floor on benefits. Further justification 
might be the inability of planners to anticipate the severity of the 
present recession. On the other hand, such "temporary" measures 
could become permanent; they would violate social security's "earned 
right" principle and would be a basic change in the self -financing 
structure of the program with its built-in restraints. It is argued that 
the Social Security System should be supported directly by those 
who are to benefit from it and that the support should be obvious. 

Another "earmarked" excise lax 

It would be possible to impose an excise tax on some service or 
commodity such as energy and "earmark" the proceeds for the OASDI 
funds. Such a financing method would avoid the argument that the 
payroll tax is regressive but, depending on the tax base, might create 
another instance of regressive taxation. The problem of linked long-run 
benefit increases would not be present, but the objections to general 
fund financing would also apply to this type of financing. It should 
also be borne in mind that a wide variety of redistributional and 
economic effects can result from excise taxes as from other taxes. 
Also, the budgetary inflexibility associated with earmarking funds for 
special purposes is an argument against this approach. 

Possible Benefit Adjustment Solutions to the Short-Run 



Alternative ways of reducing benefit payments to reduce or avoid 
OASDI deficits include — 

(1) placing a "cap" on cost-of-living adjustments in benefits; 

(2) incorporating a "needs" test for secondary benefits; 

(3) phasing out the minimum benefit payment; 

(4) phasing out student benefits ; 

(5) converting the "retirement" test from a monthly to an annual 

income test; or 

(6) eliminating the lump sum benefit option. 

It is doubtful if benefit changes could be large enough or accomp- 
plished soon enough to solve the short-range problem all by themselves, 

"Capping" cost-of-living adjustments 

In his 1976 budget request last year, the President recommended 
placing a limit of 5 percent on the fiscal 1976 adjustments in all 
income security programs tied to increases in the consumer price 
index. This recommendation did not meet with Congressional favor. 
The objection to limiting cost-of-living adjustments for OASDI 
benefits is that these beneficiaries are hit hardest by inflation and 
are least able to take steps to offset the real income loss. "Capping" 
of benefits for a couple of years, if not later made up and if in an 
appropriate amount, could permanently solve the short-run problem 
at the expense of permanently lower benefits. 


"Needs" testing for secondary beneficiaries 

It has been suggested that benefits should be made available to 
the dependents of the primary beneficiary (the worker on whose 
earnings the social security tax was paid) only upon a showing of 
need or actual financial dependence on the primary beneficiary. 
The annual combined saving in benefit payments from this alternative 
and the phasing out of the minimum benefits alternative discussed 
below would gradually increase over time to about $1.2 billion in 
1981. The objection to "needs" testing is that it would turn the 
Social Security System into a welfare program and introduce new 
administrative complexities into the system. 

Phasing out minimum benefit 

At present, any individual who has earned as little as $50 a quarter 
in covered employment for the number of quarters needed to retire is 
entitled to a $101.40 monthly benefit, whereas, an individual who has 
worked all his life at the Federal minimum wage would receive a $196 
monthly benefit. Since the minimum benefit frequently provides a 
"windfall" for persons who were only infrequently employed or who 
were fully employed under another retirement system it could be 
phased out by eliminating it for future retirees. The objection to this 
alternative would be that, for some beneficiaries who cannot qualify 
for welfare, a major source of income would be reduced. 

Phasing out student benefits 

The President's 1977 budget proposes to phase out over a 4-year 
period the provision of present law which entitles a child of a deceased 
worker to receive benefits until the age 22, without proof of need, if 
he or she attends school. It is argued that it is preferable to have 
needy students rely on programs specifically designed to aid students. 
However, about 20 percent of students now receiving student aid 
also receive social security benefits, so these two sources of aid are 
supplementary, not complete substitutes. 

Converting the retirement test to an annual basis 

The President's budget for 1977 proposes legislation to eliminate 
the present practice whereby some beneficiaries concentrate large 
annual earnings into one or two months during which they "go off" 
social security but still collect full benefits for the remainder of the 
year. It can be argued that converting to an annual test will discourage 
some beneficiaries from working at all. The funds will benefit by 
making less payments. 

Prohibiting the lump-sum benefit option 

The President's 1977 budget proposes elimination of the present 
option granted to people retiring after minimum retirement age to take 
on an annuity based on either actual age, or a lesser annuity, plus a 
lump sum equal to all monthly payments between minimum retire- 
ment age and the age of actual retirement. The justification presented 
for this amendment is that the individual should take the higher 


monthly payments and that the initial lump sum drain on the OASI 
fund would be eliminated. It can be argued that the lump sum option 
i< Useful to the retired person in adjusting to retirement. The proposal 
would result in higher long-term benefits. 

Delay in or Avoidance of Corrective Action on the Short-Run 


It is being argued that action to correct the short-run problem is not 
necessary now because the danger of exhausting the funds appears 
less acute, that additional time is needed to be sure that any short-run 
solution is consistent with or an integral part of the solution to the 
long-run problem, and that additional taxes under present economic 
conditions can add to inflation and interfere with recovery from the 
recession. It is also argued that the prospective future deficits will not 
exhaust the reserves until the long-range funding problem begins to 
take effect after 1981, by which time a long-range solution must be in 
place. The arguments against this delay strategy are that economic 
projections are not sufficiently reliable to insure that the reserves will 
not be prematurely exhausted and that, in any case, the longer an 
increase in revenues is delayed, the larger must be the eventual 
increase. On the other hand, it can be argued that benefits are really 
paid from current income, that rates should be adjusted from year to 
year, and that the reserves are not needed except to maintain the 
appearance of a funded annuity system. The President's proposal 
would build up reserves to $73 billion by 1981, compared to annual 
benefit payments of $122 billion. 


The long-range social security problem is the result of (1) demo- 
graphic factors caused by the post World War II "baby boom" and an 
unanticipated rapid decline in the birth rate in this country in the late 
1960's and early 1970's, and (2) a flaw in the statutory benefit formula 
which overadjusts benefits for the effects of price inflation. 


The Brookings Institution's publication, "Setting National Priori- 
ties, The 1976 Budget," indicates that there are now about 3.2 workers 
in the labor force for every beneficiar} T , but that in 70 years there will 
be only slightly more than two workers per beneficiary. This demo- 
graphic change will, of itself, force a change in the tax structure, or in 
benefits, or both. 

The decoupling issue 

The flaw in the rate structure is frequently referred to as a problem 
requiring "decoupling" and accounts for about half of the long-range 
deficit. The error in the social security law is that, despite the fact that 
inflation operates to increase the wage base on which benefits are 
calculated, the benefit formula applied to the higher wage base also 
contains an adjustment for CPI increases. The result is that the formula 
overcompensates for the inflation-caused increases occurring while the 
worker in is the labor force. If uncorrected, this error will cause some 
workers to receive more in periodic benefits than they receive in wages 


before retirement. The issue is not related to the upward adjustment 
of benefits that the law provides for cost-of-living increases which 
occur after retirement. 

Corrective legislation, which is necessarily technical in nature, could 
take any of several approaches. The legislation the Administration 
will propose is intended to have the effect of maintaining for the average 
retiree the same ratio of benefits to pre-retirement income as is pro- 
vided for the average person retiring today. Correction of this effect 
in the social security law will eliminate about half of the long-term 
deficit in the OASDl system. 

Overcoming the remaining long-term deficit 

To eliminate the rest of the long-term deficit, a modification of the 
tax structure, or the benefit structure, or both, will be required. Care 
must be exercised to insure that changes intended to overcome the 
long-term problem do not make the short-term problem unmanage- 
able. Similarly, the changes made to deal with the short-term problem 
must be carefully evaluated for their long-term impacts on the system. 

As to the burden on future workers of supporting a greater proportion 
of elderly persons, it has been pointed out that the dependency ratio 
for the combination of children and aged will be lower in all future 
years than the same ratio for the present population distribution, 
assuming no new "baby boom" develops. The following chart illustrates 
this point. 

Number dependent per 
Numbers of — 100 workers 


Aged Workers Chil- Aged Chil- Total 
dren dren 

1973 21,916 117,956 79,665 18.6 67.5 86.1 

2000 30, 214 157, 038 76, 333 19. 2 48. 6 67. 8 

2030 51, 227 167, 873 80, 768 31. 1 49. 1 80. 2 

2050 49, 352 173, 843 84, 462 28. 4 48. 6 77. 

Source: House Select Committee on Aging Hearings, Apr. 29, 1975, p. 11. 

Since the technical work of developing benefit and revenue alter- 
natives for solution of the demographic-related portion of the long- 
term financing problem is not yet far advanced, no attempt has been 
made here to deal with such alternatives, but it is necessary to re- 
member that the longer the dela}^ before solutions are found, the more 
costly will be the solutions when put in place. 


The present system of health insurance fails to provide for protection 
against catastrophic health care expenses, such as extended hospital- 
ization, at a reasonable cost. Those who favor some form of federalized 
catastrophic insurance argue that protection against catastrophic 
illnesses add only marginally to health care costs due to their rarity. 1 

1 The illnesses most often associated with lengthy or repeated hospitalization 
include kidney disease, premature birth, respiratory tuberculosis, cancer, diabetes, 
chronic brain disorders, psychosis, nervous system disease, heart disease or strokes, 
various types of fractures, head injuries, and burns. 

Those opposing it stress the possible inflationary effect that the 
introduction of a national catastrophic insurance program could 
have. In addition, such protection may establish strong incentives 
for costly high-technology care in lieu of greater investment in pre- 
ventive health services. 

Several plans have been proposed to provide protection against 
catastrophic medical costs. In any of these catastrophic insurance 
programs the important variables that would influence the budget 
impact include the level of protection provided, the extent to which it 
is tax — as opposed to premium — financed, and the extent to winch the 
program imposes cost controls. 

President's proposed legislation 

Under the President's proposed legislation to limit expenses for 
Medicare beneficiaries, catastrophic protection would be achieved by 
limiting beneficiary cost-sharing to $500 annually for covered stervices 
under hospital insurance (HI) and $250 annually for services covered 
by supplementary medical insurance (SMI). 

The limits would not apply to services which are excluded from 
reimbursement under current legislation. For example, beneficiaries 
would continue to be responsible for that portion of physician fees 
which exceed Medicare reasonable charge levels. Out-of-pocket 
expenditures for payment of "excess charge" physician fees would not 
count toward satisfying the $250 SMI deductible. Similarly, ex- 

enditures for non-covered services (such as drugs, eyeglasses, and 

earing aids) would also be excluded. 

If the President's proposal is accepted in its entirety, including the 
10 percent HI co-insurance, approximately 1 million out of the 5.9 
million persons using Hi-covered services in 1977 will benefit from the 
$500 cap. HEW estimates the cost of providing this protection under 
HI at $0.9 to $1.1 billion in fiscal 1977. ($145 million of this amount 
represents a transfer of costs from Medicaid to Medicare.) 

Alternatively, if the "catastrophic" protection proposals are imple- 
mented without the new co-insurance, a much smaller number of 
ersons will benefit from the expenditure caps. Under current law, a 
eneficiary is responsible for an HI deductible equal to the average 
cost of one day's hospitalization. After that, Medicare pays the full 
cost of Hi-covered services through the 60th day of hospitalization, 
after which the beneficiary pays one-fourth of the deductible until 
the 91st day, and one-half of the cost from the 91st day until coverage 
is exhausted. 

Therefore, under current cost-sharing provisions, a Medicare 
recipient would have to be hospitalized for 73 days before benefitting 
from the $500 cap. Fifty thousand recipients would qualify under 
current law. Approximately 95 percent of Medicare hospital stays 
end at least 2 weeks before the 61st day when co-insurance now be- 
comes operative. Only 4 percent exceed 61 days. 

In fiscal 1977, the cost of eliminating all hospital coverage after 
the 60th day, excluding the first day deductible under current law, 
would be approximately $208 million. Thus, $712 million (77 percent) 
of the President's $920 million HI "catastrophic" benefits is estimated 
to result from his proposed 10-percent cost sharing. 


The Administration estimates that the $250 SMI cap will assist 2 
million of the 14.2 million beneficiaries using SMI-covered services in 
1977 at a cost of $208 million. This proposal will chiefly benefit the 
disabled and chronic renal disease beneficiaries whose per capita 
SMI costs are significantly higher than those of the aged. 

For the general class of Medicare recipients, the Administration's 
SMI proposal fails to address their most significant burden from 
non-hospital costs — physician fees that exceed Medicare's reasonable 
charge level and must be paid directly by the patient. In 1975, of the 
$2.7 billion SMI charges submitted directly by the beneficiaries 
(i.e., cases where the physician refused "assignment"), 16.6 percent 
of billed charges, or $448 million, was denied as excessive. Seventy- 
seven percent of all claims were reduced, the reductions averaging 

Catastrophic Health Insurance and Medical Assistance 
Reform Act of 1975 (S. 2470) 

S. 2470 is a three-part bill sponsored by Senator Long. It is designed 
to meet the health care financing needs of all Americans with large 
or catastrophic health care costs and to restructure the Medicaid 
programs to provide basic health care for all low-income individuals. 
The bill provides for a catastrophic health insurance program for all 
U.S. residents through a federally administered public plan for the 
unemployed, welfare recipients, the aged, and persons who do not 
opt for private insurance coverage, or a privately administered plan 
allowed as an option for employers and the self-employed. Benefits 
of the program would be similar to those currently covered under 
Medicare. These benefits would begin after the beneficiary had 
incurred medical expenses of $2,000 or had been hospitalized for 60 
days. The catastrophic program would be financed through a 1- 
percent payroll tax, offset by a 50-percent tax credit for all contrib- 
uting employers. S. 2470 would replace the existing Medicaid pro- 
gram with a uniform, national program of medical benefits for all 
low-income individuals and families whether the}' are on welfare or 

The estimated cost of the catastrophic program is from $7. of to 
$8.5 billion for fiscal 1977. This would be financed by the payroll 
tax. Approximately $2.6 billion is now being spent under current 
law for Medicare and Medicaid to pay for services that would be 
covered under the Long-Ribicoff bill. Medicaid reform would cost 
about $8 billion more than under current law. 


Civil Service Retirement 

The current civil service retirement system provides for optional 
retirement at age 55 with 30 years of service, at age 60 with 20 years, 
or at age 62 with 5 years. The lifetime base annuity is computed by 
using the average salary for the 3 years of highest earnings. The 
annuity increases as a percent of average salary depending on length 
of service — 7.5 percent with 5 years of service, 36.25 percent f with 20 
years, 56.25 with 30 years. The maximum benefit is 80 percent after 
42 years of service. 


Basic annuities are indexed to increase whenever the consumer price 
index rises by 3 percent and remains at that level for 3 consecutive 
months. The size of the cost-of-living adjustment is determined by 
the percent increase in the consumer price index between the last 
base month and the highest-cost month in the 3-month period. The 
increase becomes effective 3 months later. An extra percentage point — 
commonly referred to as the "1 percent kicker" — is added to com- 
pensate for a lag between price increases and the effective dates of 

Two other provisions in law for determining the size of the first 
post-retirement adjustment also increase the annuity above con- 
siderations of salary and service alone: 

First, the initial cost-of-living adjustment is not prorated to 
reflect the time an employee has actually been in retired status 
since the last increase. Consequently, an employee retiring the 
day before the effective date of the adjustment receives the 
full increase even though there has been virtually no decrease in 
purchasing power for that retiree. 

Second, an employee is entitled to receive no less than the most 
recent cost-of-living increase predating his retirement. This is 
commonly referred to as the "look-back provision." 

The combined effects of the "1 percent kicker" and the first post- 
retirement adjustment provisions overcompensate for inflation over 
the 20-3^ear average life span for civilian retirees. Other Federal 
programs which are indexed for price changes do not provide for such 
frequent or liberal adjustments. Social security payments are adjusted 
once a year with a 5-month lag ; food stamps are indexed twice a year 
with a 1-month lag; white-collar civilian and military pay are adjusted 
once a year with a 6-month lag. 

From 1975 to 1981, outlays for civil service retirement and disability 
are expected to more than double — rising from $7.0 billion in 1975 to 
$16.5 billion under CBO Path B growth rate. 

During the 5 years between 1977 and 1981, projected cumulative 
outlays would total nearly $67 billion, a cumulative increase of $21 
billion over an annual straight-line projection of the Transition 
Quarter estimate. The additional outlays are attributable largely to a 
24-percent increase in the number of beneficiaries and to cost-of-living 
adjustments. The remainder of the increase would be due to changes in 
employee earning rates. 

Elimination of the so-called "1 percent kicker" in fiscal 1977 would 
reduce outlays for civil service retirement by $93 million in the fust 
year and accelerate to an annual reduction of nearly $1 billion by 19S1 
using CBO's fast-growth assumptions. 

Income to the civil service retirement fund is treated as budget 
authority (permanent, indefinite) and comes from three primary 
sources : 

(1) Employer (agency) and employee contributions. These contribu- 
tions, set by statute, are now 14 percent of pay and are divided equally 
between employer and employee. The contribution level is intended to 
cover the actuarial or "normal cost" of benefits for a new retiree who 
has been employed by the Government for the full number of required 
service years. In practice, however, the contribution level does not 
cover full cost because it excludes anticipated increases in cost-of- 
living, salaries, and interest rates. 


(2) Extra Federal contribution, which includes two parts: (a) pay- 
ments for 30-year amortization of any increased liability created by 
pay raises, benefit liberalizations, or extensions of coverage; and (6) 
payments equivalent to an increasing percentage of interest on un- 
funded liability which was initiated in 1971 at 10 percent of interest, 
and scheduled to reach 70 percent in fiscal 1977 and 100 percent by 
fiscal 1980. 

(3) Interest earned on balances in the fund which are invested in U.S. 
securities. Balances in the retirement fund accumulate from excess 
income (including interest earned) over outgo for payment of bene- 
ficiaries. Balances increased from $22.4 billion on June 30, 1971, (the 
year before in-lieu-of-interest payments) to $38.7 billion on June 30, 
1975. Assuming no change in benefits or current provision for indexa- 
tion, fund balances are projected to reach $80.7 billion by 1981 under 
CBO's fast-growth assumption. If the "1 percent kicker" were 
eliminated, the balance by 1981 would increase to $82.4 billion as a 
result of a lower level of outlays over the 5-year period. 

After 1981, the balances should continue to increase at a more level 
rate and the fund should be able to meet its requirements — so long as 
new employees continue to enroll in the system and salary and 
interest rates increase in the long run slightly faster than the cost-of- 
living. By 1981 annual income from the fund will exceed outgo by 
about $9.0 billion, or $9.6 billion with elimination of the "1 percent 

Military Retirement 

The military retirement system pays a lifetime annuity which can 
begin after 20 years of service. The annuity after 20 y ears is 50 percent 
of basic pay at the time of retirement, rising to 75 percent with 30 years 
of service. Military personnel do not contribute directly to the retire- 
ment system. The benefits, and the lack of an offsetting contribution, 
make military retirement very expensive. In fiscal 1976, the Defense 
Department will spend about $7.4 billion — some 8 percent of all 
defense outlays — on retirement. Costs will increase to $12.8 billion by 
fiscal 1981 and represent 9 percent of all defense outlays. 

Military personnel who leave service with less than 20 y ears receive 
no pension. As a result, the retirement system provides virtually no 
incentive for younger personnel to reenlist after their first tour of duty 
when retirement still is as much as 16 years in the future. As a result, 
most recruits leave after their first tour. Of those who reenlist after 
that tour, most remain in service for a full 20 years. Few personnel 
remain in service after 20 years, however. Thus, the system is not 
designed to encourage younger personnel to remain in service so that 
the Defense Establishment can obtain a return on the heav}' invest- 
ment in their training. Nor does the system seem to encourage many 
highly experienced personnel to stay on active duty after 20 years. 

The Retirement Modernization Act, which is currently before 
Congress, is designed to reduce the number of 20-year retirements 
slightly and increase the number of reenlistments. The plan would 
provide limited retirement benefits after 10 years of service which 
makes first reenlistments more attractive. It would reduce the basic 
annuity after 20 years of service from 50 percent to 35 percent for the 
first 10 years of retirement, which encourages experienced personnel to 
stay on active duty. 


The plan would increase military retirement costs during its first 
few years of operation because of increased benefits for personnel who 
retired after 10 years, but the Defense Department estimates that the 
plan would cut retirement costs by $800 million in current dollars 
by the year 2000. Other plans to save even more funds have been 

Military pension payments are indexed to the consumer price index 
on essentially the same basis as civil service pensions and include the 
"1 percent kicker" designed to compensate for lags between price 
increases and annuity increase. 

The same arguments that are made against the "kicker" for civil 
service pensions apply to military annuities. Since the clause became 
effective, there have been nine increases which have increased annuities 
by 63 percent. During that time, the cost of living has increased by 
only 50 percent. The Defense Department would save $90 million 
in fiscal 1977 if the kicker were eliminated and more than $600 million 
in fiscal 1981. 

Without the 1 percent bonus, military retirees would be slightly 
undercompensated for price increases because of the lag between price 
and annuity increases. However, there are other ways to cure the 
problem. For instance, a lump sum could be added to the first check 
after a consumer price adjustment was made. In an interim report, 
the Defense Manpower Commission (DMC) has proposed a way of 
calculating the required lump sum payment. Adopting the DMC 
lump sum payment would dramatically affect savings. Eliminating 
the kicker and adopting the DMC lump sum payment would 
actually increase military retirement costs in fiscal 1977 by over $300 
million dollars. In fact, costs would increase in 3 of the 5 years from 
1977 to 1981. Of course, in the long run eliminating the kicker and 
adopting the DMC lump sum payment would still save significant 

Unlike Federal, State and local civil servants and many employees 
of private firms, military personnel make no cash contribution toward 
their retirement system. Several methods for initiating a contributory 
system have been proposed, each carrying savings to the Federal 

It is not clear whether imposing a contributor} 7 system on the present 
military retirement s}^stem is desirable. By cutting the pay, in effect, 
of personnel who stay in the service until retirement, a contributory 
plan might reduce the number of 20-year careerists; such a reduction 
is probably desirable since 20-year careerists are expensive. But a 
contributory plan may reduce 20-year careerists by cutting first- 
term rcenlistments; this is probably undesirable since the military 
loses members in whom it has recently made substantial training 
investments. Because of these consequences, a contributory retire- 
ment program should probably be considered along with benefit 
reform- such as the Retirement Modernization Act. These benefit 
reforms can incorporate the desirable features of contributory retire- 
ment while offsetting undesirable ones. 

This report has examined two levels of contribution toward military 
retirement — a 7-percent individual contribution, which is the level 
at which Federal civil servants contribute to their retirement fund, 
and a 10-percent contribution which might be more appropriate 
in view of the more generous retirement benefits in military service. 


Even a 10-percent contribution would fall short of fully funding 
rnilitarjr retirement. An enlisted man retiring as an E-7 after 20 
years of service would have had to contribute 80 percent of his basic 
pay each year — or 40 percent if the contribution were matched by the 
Defense Department — to fully fund his retirement if one assumes 
only a 3-percent annual inflation rate. An officer retiring as an 0-6 
after 30 years would have had to contribute about 60 percent of his 
base pay throughout his career, again assuming 3 percent inflation. 
These percents do not of course imply that Defense would have to set 
aside 60 to 80 percent of basic pay to fully fund military retirement 
since many military members do not stay until retirement. 

Consistency with the Federal Civil Service System would suggest 
a compulsory contribution for military personnel. However, civil 
servants are not covered by social security, which is one reason their 
retirement payments are compulsory. Military personnel, on the 
other hand, are required to participate in social security. As long as 
that requirement remains in effect, there would be an argument for 
putting contributions for military personnel on a voluntary basis. 

A voluntary option would avoid deductions from junior personnel 
who did not wish to participate. Under a compulsory option these 
deductions, even though they would eventually be refunded if the 
person left before retirement, might make recruiting more difficult by 
lowering starting take-home pay. Also the prospect of a large lump sum 
refund if one chooses not to reenlist may cut down on reenlistments. 
On the other hand, a voluntary option has the major disadvantage that 
personnel who elect not to participate in the first years they are in the 
military, but who later are considering a career and wish to partici- 
pate, would be faced with -a large make-up payment which might 
cause them to decide against a career. Some advantages of both 
options might be obtained by making the system voluntary up to 5 
years of service and compulsory thereafter. 

All options assume that military members would still be required to 
participate in social security. This assumption would make the new 
military retirement system different from its civil service counterpart, 
whose members are exempt from social security, but not different from 
most private pension plans. Keeping the military in social security 
would avoid any adverse short-run effect on funding of the Social 
Security System. Taking the military out of social security would 
reduce the system's current income by almost $2 billion per year but 
would not reduce benefit payments for many years. All options also 
assume that military contributions would be taxable, as is now the 
case for civil service contributions. 


Table 1 below indicates savings to the government under the 7 per- 
cent and 10 percent options and, within each, under a voluntary and 
compulsory option. Savings under the voluntary options assume "per- 
fect foresight'' (i.e., only those who eventually retire choose to par- 
ticipate) . Savings under the compulsory options are based on estimates 
adjusted for inflation. 

Table 1 reflects all major savings in fiscal 1977-1981, but savings 
may change in the longer run. By reducing the take-home pay of those 
continuing to retirement, a contributory retirement system should 
reduce the numbers who stay until retirement. Fewer personnel con- 


tinuing to retirement would eventually save money by reducing the 
costs of military retirement. On the other hand, higher losses will in- 
crease the costs of recruiting and training. Even though neither of 
these increases or decreases in costs are included in the savings in 
Table 1, they should have little effect on costs in fiscal 1977-1981. 


[In millions of dollars; Path B inflation ! ] 

Fiscal year — 

1977 1978 1979 1980 1981 

Military retirement (current 


8, 600 





11, 700 



Eliminate 1 percent kicker 






Contributory retirement : 

Voluntary, 7 percent 






Voluntary. 10 percent 

-1, 000 





-1, 250 



Compulsory, 7 percent 

-1, 200 



— 1, 


-1, 150 



Compulsory, 10 percent.. 

-1, 700 





-1, 650 



1 Path B inflation percentages as follows: 

Fiscal year — 
1977 1978 1979 19S0 1981 

CPI 6. 7 5. 5. 9 4. 5 4. 8 

Wages 12. 8. 8 8. 3 6. 9 6. 9 

Source: Congressional Budget Office. 

The savings in Table 1 do not consider tax effects. Currently, almost 
all military annuities are taxable. But if military contributions are 
taxed (as is assumed in Table 1), then annuity payments up to the 
amount of the contribution should be tax free. Thus, some fraction 
of the savings, perhaps 20 percent or so, would eventually be lost to 
the government through reduced tax revenue. But there would be little 
effect in the first few }^ears and hence little effect on the savings in 
table 1. 



Congress has before it several proposals for reforms in veterans' 
pensions, the black lung disability program and supplemental security 
income. Another bill would increase the retirement income tax credit. 

This section discusses the background and budgetary impact of 
each of the proposals for change. 


Veterans and Survivors Pensions 


Under current law a needy, wartime veteran is eligible for pension 
benefits if he has a total and permanent non-service-connected dis- 
ability or is age 65 or older. Needy widows and minor children of de- 
ceased wartime veterans also are eligible for pension benefits. 

Provisions of existing law which determine the amount of pension 
payments that eligible veterans or their survivors receive have resulted 
in inequitable treatment among pension recipients and are incon- 
sistent with the principles of other Federal income security programs. 
The pension reform provisions of S. 2635 retain the basic eligibility 
tests of current law while restructing the pension program itself. 

The goal of S. 2635 is to correct inequities and technical problems 
in the current VA pension program. Such corrections are intended to 
result in a better targeting of funds on the neediest recipients. Major 
reform provisions include — 

(a) the creation of a system which more smoothly relates benefits 
to income; 

(6) an automatic adjustment in the basic level of annual income 
wherever social security benefits are increased; 

(c) elimination of 11 of the 18 existing income exclusions, 

including the total exclusion of spouses' earned income 
in pension payment calculations; 

(d) equalization of widows' benefit rates; and 

(e) revisions in the aid and attendance allowance and house- 

bound allowance payment system. 

Budgetary impact 

The Congressional Budget Office and the Veterans Administration 
have provided the Senate Budget Committee with estimates of the 
fiscal 1977 costs of implementing the pension reforms of S. 2635. 
Based on the best available data, it is estimated that the pension 
reform package will have a net cost of from $390 to $460 million in 
fiscal 1977 over and above the cost of extending current pension 
law with anticipated cost-of-living increases. Included in the 1977 
estimate are offsets that would result because of reduced SSI and 
food stamp benefits which many individuals eligible for pension 
benefits are now receiving. 

The number of veterans' pension beneficiaries is expected to increase 
markedly in the next decade as large numbers of World War II 
veterans reach retirement age. Thus, a corresponding growth in total 
pension payments can be expected to occur during that period. This 
trend was taken into consideration when the Senate Committee on 
Veterans Affairs developed S. 2635. Because the final pension reform 
package has restructured the pension program by simultaneously in- 
creasing benefits to the neediest veterans and lowering eligibility for 
those benefits, Congress can expect a control of program growth as 


World War II veterans enter the system. Although 5-year projections, 
are difficult to make because of a lack of detailed information about 
the age and income characteristics of the future aged veteran popula- 
tion, the evidence suggests that S. 2635 would result in a long-term 
cost-savings by the mid-1 980's. 

Status of legislation and schedule for action 

S. 2635 was passed by the Senate in December 1975. Because the 
pension reforms will affect fiscal 1977, a Budget Control Act section 
303(a)(4) waiver was required prior to consideration of S. 2635 on the 
Senate floor. The Senate Budget Committee favorably reported the 
waiver resolution in view of the Senate Veterans Committee's efforts 
to encourage the House to accept pension reforms. The waiver resolu- 
tion was agreed to by the Senate prior to passage of S. 2635. Although 
the House Committee on Veterans Affairs has not yet considered 
pension reform measures, it is expected to do so in the near future so 
that legislation can be agreed to by the House and the Senate by early 

On December 17th and 18th, the Senate and House respectively 
agreed to H.R. 10355, a bill to provide an 8-percent cost-of-living 
increase to veteran pensioners. Prior to Senate passage of H.R. 10355, 
an amendment was added to the bill which limits the 8 percent increase 
to a period beginning January 1, 1976 and ending September 30, 1976. 
By adding this amendment, the Senate hoped to spur House considera- 
tion of pension reform measures. 

Coal Miners Disability 


The Federal Coal Mine Health and Safety Act of 1969 was developed 
as a response to the black-lung related health and compensation 
needs of disabled miners in coal-producing States. 

The act provided for the development and implementation of health 
and safety standards to minimize conditions in mines which cause 
black lung disease; creation of a Federally financed compensatory 
income and health benefits program for disabled miners and their 
survivors; and development of a program, effective in 1973, that would 
relieve the Federal Government of future liability for miners' com- 
pensatory benefits through a system of State-administered compensa- 
tion plans financed through assessments on coal mine operators. 

By the early 1970's, it was apparent that many disabled miners and 
their survivors were not technically eligible for benefits and that the 
proposed 1969 plan for transferring the total responsibility for black 
lung payments from the Federal Government to the States and coal 
mine operators was unworkable. In an attempt to resolve these and 
other specific problems, the House Committee on Education and Labor 
has reported a bill, H.R. 10760, to amend the Federal Coal Mine 
Health and Safety Act. Major amendments include a number of pro- 


visions to expand the beneficiary population and provisions establish- 
ing a non-governmental trust fund financed by an assessment on all 
mine operators but initially funded by a repayable U.S. Treasury loan. 
The new trust fund would assume total responsibility for the payment 
of black lung benefits to those miners and their survivors who applied 
for benefits after December 31, 1973, as well as to those miners and 
their survivors eligible to apply for benefits under the new law. The 
Federal Government would continue to be liable for the payment of 
black-lung benefits to those miners and their survivors who applied 
for benefits on or prior to December 31, 1973. 

Budgetary impact 

The Congressional Budget Office estimate of costs for H.R. 10760 
indicates that provisions of the bill expanding the beneficiary popula- 
tion would add $122 million to the estimated $1 billion to be paid 
miners in fiscal 1977 under existing entitlement law. Further, the 
reimbursable trust fund loan would result in an additional expenditure 
by the government during fiscal 1977 of $67 million, for a total cost of 
$189 million in fiscal 1977. It should be noted that the trust fund will 
be assuming the liability for a projected $38 million in black-lung 
benefits which the Federal Government would continue to be respon- 
sible for without changes in the law. Therefore, the estimated expendi- 
tures of $189 million should be reduced by $38 million to get an ac- 
curate picture of the net cost ($151 million) to the Federal Govern- 
ment of H.R. 10760. 

By fiscal 1982, the loan payback with interest, the decreasing benefit 
payment total due to the mortality rate of miners and their dependents 
for which the Federal Government will retain liability, and the savings 
to government resulting from the trust fund arrangement should 
produce a total savings of $1 million during that year. 

The language in H.R. 10760 is unclear and there is some question as 
to whether the initial trust fund loan will be regarded as an off-budget 
item. Although the net cost estimates made by CBO will remain the 
same regardless of the outcome of this decision or subsequent language 
changes made in H.R. 10760, the specific budgetary impact is difficult 
to ascertain. If the trust fund is determined to be on-budget, outlays 
will be increased by $67 million. If the trust fund is determined to be 
off-budget, outlays will not reflect the $67 million loan to be made to 
the trust fund by the Treasur}'. It is likely that this issue will be 
resolved prior to final passage of H.R. 10760 by the House. 

Status of legislation and schedule for action 

The House Committee on Education and Labor reported H.R. 10760 
on December 31, 1975. The bill is presently awaiting floor action. 
Consideration of the bill by the House prior to May 15, 1976, would 
require a Budget Control Act section 303(a) waiver resolution. 

There is no comparable black-lung legislation pending before the 
Senate, but the Senate is likely to give such legislation rapid review 
once a bill is passed by the House. 


Supplementary Security Income 


H.R. 8912) 

Both H.R. 8911 and H.R. 8912 would liberalize the supplemen- 
tal security income program by amending Title XVI of the Social 
Security Act. 

In addition to a number of programmatic, eligibility, and benefit 
changes with negligible or small growth effects, these bills would — 

(a) extend presumptive SSI eligibility to blind individuals: 

(b) provide for a mandatory "pass-through" by States of Federal 

SSI increases, with Federal fiscal protection against the 
increased State costs of such a requirement provided to 
six States; 

(c) extend the SSI program to Puerto Rico, Guam, and the 

Virgin Islands; 

(d) change from 33 percent to 20 percent the reduction in bene- 

fits for an individual when he is living in the household of 
another person and receiving: in-kind support; 

(e) provide for the exclusion of SSI cost-of-living increases in the 

determination of income in computing eligibility for 
benefits under various housing assistance programs; and 
(J) change existing law to allow an SSI recipient to receive 
additional financial assistance for housing costs if these 
costs exceed 33^ percent of the recipient's annual income. 

It is the intent of this legislation to alleviate the financial burden on 
SSI recipients who, because of local market conditions, are forced to 
pay housing costs that are beyond their limited means. 

Budgetary impact 

The Administration's cost estimates indicate that the first full- 
vear cost of H.R. 8911 would be $450 million and the first full-year 
cost of H.R. 8912 would be $825 million. 

Status of legislation and schedule for action 

The Subcommittee on Public Assistance of the House Committee 
on Ways and Means has favorably reported H.R. 8911 and H.R. 8912 
to the full committee for action. At present there is no timetable for 
full committee action. The Administration opposes the more costly 
provisions of the proposed SSI revisions. 

Because amendments to the Social Security Act must technically 
be initiated bv the House, there are no Senate measures comparable 
to H.R. 8911 and H.R. 8912. If these bills were referred to the Senate 
by July i, 1976, action possibly could occur before the end of the 

Retirement Income Tax Credit 

TAX REFORM ACT OF 1975 (H.R. 10612) 

Under present law, individuals who are 65 years of age or over may 
receive an income tax credit based on the first $1,524 of retirement 


income. The credit is 15 percent of this retirement income. Each spouse 
who is 65 or over may compute his tax credit on up to $1,524 of his 
own retirement income (whether the couple files separate or joint 
returns). Alternatively, spouses 65 or over who file joint returns may 
compute their credit on up to $2,286 of retirement income (one and 
one-half times $1,524), even though one spouse received the entire 
amount of the retirement income. 

To be eligible for the credit an individual must have received more 
than $600 of earned income in each of the prior 10 years. (A widow 
or widower whose spouse had received such earned income is con- 
sidered to have met this earned income test.) 

Retirement income, for purposes of this credit, includes taxable 
pensions and annuities, interest, rents, dividends, and interest on 
Government bonds issued especially for the self-employed setting 
aside amounts under retirement-type plans. 

The maximum amount of retirement income which an individual 
may claim ($1,524, or $2,286 for certain married couples) must be 
reduced by two broad categories of receipts. First, it must be reduced 
on a dollar-for-dollar basis by the amount of social security, railroad 
retirement, or other exempt pension income received by the taxpayer. 
Second, the maximum amount of retirement income eligible for the 
credit is further reduced by one-half of the annual amount of earned 
income over $1,200 and under $1,700 and by the entire amount of 
earned income in excess of $1,700. This reduction for earned income 
does not apply to individuals who have reached age 72. 

Individuals under age 65 also are eligible for tax credits for retire- 
ment income but only with respect to pensions received under a public 
retirement system. Only income from a pension, annuity, retirement, 
or similar fund or system established by the United States, a State, 
or a local government, qualifies under this provision. This restriction 
of retirement income for purposes of the credit to income from a 
public retirement system applies only until the individual reaches the 
age of 65 ; thereafter he is entitled to take the credit on the same basis 
as other individuals who have reached that age. 

H.R. 10612 proposes a redesign of the present retirement income 
credit for several basic reasons. One reason is that the credit needs 
updating. Most of the features of the present credit have not been 
revised since 1962 when the maximum level of income on which the 
credit is computed was set and when the current earnings limits were 
established. Since then, there have been numerous revisions of the 
social security law which substantially liberalized the social security 
benefits. As a result, the present maximum amount of income eligible 
for the credit is considerably below the average annual social security 
primary benefit of $2,271 received by a retired worker and the average 
social security primary and supplementary benefit of slightly over 
$3,400 that could be received by a retired worker and his spouse. 

In addition, the complexity of the present retirement income credit 
prevents it from providing the full measure of relief it was intended to 
grant to elderly people. 

The purpose of all these provisions is to provide individuals who 
receive little or no social security benefits the opportunity to receive 
tax treatment roughly comparable to that accorded those who get 
tax-exempt social security benefits. However, the result has been to 
impose severe compliance burdens on large numbers of elderly people, 

72-678—76 9 


many of whom are not skillful in filing tax returns. These complexities 
undoubtedly account for the estimate that as many as one-half of all 
elderly individuals eligible to use the retirement income credit do not 
claim this credit on their tax returns. 

The present retirement income credit discriminates against in- 
dividuals with modest income depending on the source of their income . 
As indicated above, the credit is available only to those with some 
form of investment or pension income in the taxable year. Elderly 
individuals who must support themselves by earning modest amounts 
and who have no investment or pension income are not eligible for 
any relief under the present credit. This has given rise to considerable 
criticism as to the fairness of the tax law; many elderly individuals 
who rely entirely on earned income maintain that they should be 
allowed the same retirement income credit as those who live on invest- 
ment income. Under the present credit, elderly people who rely entirely 
on earned income are required to pay substantially higher taxes than 
individuals who are comparable in every respect except that they have 
significantly larger incomes which come from investments. Another 
criticism is that higher taxes on earnings than on retirement income 
serve as a disincentive to work. 

To deal with the problems described above, the bill would update 
the amount on which the credit is based. It would deal with the prob- 
lem of complexity by no longer attempting to pattern the credit closely 
after the social security provisions. Instead, to the extent practical, 
complicating features of the credit which previously were included in 
order to parallel social security treatment are eliminated. Thus the 
$600 for 10-years' earnings test is eliminated, as is the requirement 
that the taxpayer have "retirement income" (that is pension or 
investment income) in order to be eligible for the credit. In addition, 
the variation in treatment of married couples depending on whether 
they are separately eligible for credits is eliminated. 

The bill would improve the equity of the provision by making the 
credit more generally available to those age 65 or over. The major 
change in this area is the elimination of the cutback of the credit for 
earned income. It was concluded, however, that in view of the broaden- 
ing of the credit generally and the change in its nature to focus relief 
on low- and middle-income taxpayers, it is not necessary to provide 
the credit to higher income taxpayers. Consequently, the maximum 
amounts of the base for the credit are reduced by one-half of the ad- 
justed gross income in excess of $7,500 for a single person and $10,000 
for a married couple filing a joint return ($5,000 for a married taxpayer 
filing a separate return). Thus, for a single person, the credit would no 
longer be available when his adjusted gross income reaches $12,500 
($7,500 plus two times $2,500). For a joint return the credit would be 
available up to an income level of $15,000 if only one spouse is age 65 
or over and up to $17,500 if both spouses are age 65 or over. 

The most significant extension of the credit is that for the first time 
it would benefit low-income earners age 65 or over regardless of whether 
they receive retirement income or earned income. Since the credit 
would no longer be limited to retirement income, it will be renamed 
the "credit for elderly." 


Budgetary impact 

These changes in the retirement income credit would reduce income 
tax revenues (increase tax expenditures) by $340 million annually. 

Status of legislation and schedule for action 

The retirement income credit provisions were included in the tax 
reform bill passed by the House last year. The Senate Finance Com- 
mittee plans to hold hearings on tax reform in March 1976, but no 
definite schedule for legislation has been set. 




This paper was prepared to provide background for the deliberations 
of the Senate Budget Committee prior to its markup of the First 
Concurrent Resolution on the Budget for Fiscal Year 1977. 

The report was prepared by Thomas A. Dine and Robert D. 
Sneed of the Senate Budget Committee staff and Robin Pirie of the 
Congressional Budget Office staff. 

Edmund S. Muskie, 




/. Introduction and Summary 

An important determinant — though not the only one — of American 
foreign and military policy, and therefore of the U.S. defense budget, 
is the Soviet Union's stance. This study is designed to examine and 
evaluate (1) the policy pressures which have pushed Soviet defense 
spending upward over the past 15 years, (2) the significance of com- 
paring U.S. and U.S.S.R. military spending, and (3) the implications 
of Soviet strength for the United States in the FY 1977 through 
FY 1981 budgets and beyond. The study is intended to serve as a 
vehicle for discussion by the Senate Budget Committee of U.S. 
strategic and general purpose force needs during the FY 1977 debate 
over the defense budget. 


Section II (pages 132-142) analyzes the Soviet Union's perception 
of its external and internal security situation. In the international 
arena, Moscow sees Peking as a "great danger," a threat about which 
Communist Party chief Leonid Brezhnev reminded the 25th Com- 
munist Party of the Soviet Union (CPSU) Congress on February 24, 
1976. Since the split between the Soviet Union and China, the U.S.S.R. 
has pursued a rapid buildup of its forces. One fourth or more of Soviet 
armed forces are deployed in Asia to counter China and the Chinese 
nuclear arsenal which is aimed at Moscow and other crucial targets 
deep inside Western Russia. 

The maintenance of the status quo in Eastern Europe is another 
primary objective of Soviet military policy; 31 Soviet Army divisions 
are deployed in Eastern Europe to maintain order according to 
Moscow's terms. 


With regard to the United States, the U.S.S.R.'s overriding objec- 
tive has been to achieve strategic nuclear parity. In 1962, the United 
States enjoyed a five-to-one superiority in strategic missiles, a three- 
to-one superiority in strateric bombers, and naval superiority on and 
under the seas. After the Cuban missile crisis, the Soviets deter- 
mined never again to be caught in similar circumstances and sought 
genuine great power status. A rough strategic equality now exists. 
Both sides maintain a strong second strike capability and will likely 
maintain such destructive capability through vigorous research and 
development programs. 



An arms competition in general purpose forces is also in process. 
In Europe, the Warsaw Pact enjoys a quantitative advantage; NATO 
has a qualitative advantage. Worldwide, the Soviet military reach 
remains modest in comparison to that of the United States. Gen. 
George S. Brown, chairman of the Joint Chiefs of Staff, pointed this 
out in his military posture statement to Congress for FY 1977. "The 
U.S.S.R. currently possesses only a limited capability," he said, 
"to project substantial general purpose military power beyond the 
Eurasian continent." 1 

Along with its strategic and conventional buildup, Moscow has 
embarked on an effort to influence events in Third World countries. 
Weapons for invention purposes are becoming a routine part of 
the Soviet inventory. The transfer of sophisticated conventional 
arms abroad, most notably before to Egypt and now to Syria, is a 
tool of Soviet diplomacy; the Soviets are currently sending materials 
to southern Africa to fuel "wars of liberation." 

Internally, a close relationship exists between Brezhnev and the 
military. At the end of the 25th Congress, for instance, Dmitri F. 
Ustinov, head of defense industries and space matters, was made 
a member of the politburo. Then with Marshal Grechko's death, 
Ustinov became defense minister. At about the same time, Brezhnev 
was elevated to the rank of marshal. Although controversy and 
uncertainty surrounds these developments, there is a clear political 
pattern: Brezhnev has provided the defense ministry, in return for 
its political support, the funds for the military buildup. 

The Soviet military posture vis-a-vis China, Eastern Europe, the 
United States, and the Third World, plus the momentum created 
by the party-military amalgam, 2 must all be weighed as the U.S. 
evaluates its own security needs in the face of the Soviet threat. 


Section III of this study (pages 143-147) asks whether a comparison 
of U.S. and U.S.S.R. military spending is relevant in evaluating 
America's military needs. Must the United States spend at a rate 
comparable to Soviet military spending to ensure America's security? 

A major administration justification for requesting a substantial 
increase in FY 1977 defense funds is the upward spending trend of the 
U.S.S.R. military budget. It is contended that, in response to the 
growth in Soviet military programs, the United States must modernize 
and expand its forces to maintain a "sufficient military capability." 

Cost comparisons, however, are crude indicators. Information on 
actual Soviet outlays is incomplete. Moreover, dollar costing of Soviet 
military programs often estimates only what an item would cost if 
produced in the United States, without taking into account Russian 
propensities toward simpler and more rugged machinery or toward 
standardization. There are similar problems with ruble costing, which 

1 Statement by Gen. George S. Brown to the Congress, "United States Military- 
Posture for FY 1977." January 20, 1976, p. 9. 

2 William E. Odom, "Who Controls Whom in Moscow." Foreign Policy, 
Summer, 1975. 


are compounded by the fact that ruble prices for Russian weapon 
systems are not always available. 3 

Whatever the methodology applied, the test of military spending is 
how much added security is bought by the money. Focusing on out- 
puts raises a more fundamental question: What kind of political will 
and military capability do the United States and NATO require 
in defending their interests and in implementing their common foreign/ 
military policy? Stated another way: Should we match inputs with 
the Soviet Union, or should the United States tailor its military 
programs to provide specific outputs where the country perceives 
the need for them? 

Secretary of State Henry Kissinger has stressed less the alleged 
weapons gap/spending gap and more the attempt "to build a pattern 
of relations in which the Soviet Union will always confront penalties 
for aggression and also acquire growing incentives for restraint.' ' 
In his March 11, 1976, Boston speech, the Secretary noted the con- 
siderable unevenness with which Soviet power is evolving, that Soviet 
society is no longer totally cutoff from contact with the influences of 
the world around it, nor is it without its own needs for more normal 
external relationships. At the same time, it is recognized that the 
Soviet Union perceives it has security needs peculiar to its own geo- 
political position. 

"Despite the inevitable increase in its power," he said, "the Soviet 
Union remains far behind us and our allies in any overall assessment 
of military, economic, and technological strength; it would be reckless 
in the extreme for the Soviet Union to challenge the industrial 
democracies." 4 


Section IV (pages 148-165) provides a quantitative comparison of 
major mission forces of the U.S. and U.S.S.R., including a presentation 
of relative NATO and Warsaw Pact force strengths. It highlights the 
substantial growth in strategic and general purpose forces the Presi- 
dent is requesting in his FY 1977 defense budget, and the implica- 
tions of this growth through FY 1981 (and beyond for selected weapon 
systems) . 

The force comparisons show increased Soviet force levels and tech- 
nological advancements. They also suggest the U.S.S.R. has achieved 
rough numerical parity in certain mission roles with the United 
States. However, it is evident that the strategic qualitative balance 
remains in favor of the United States, a lead it will retain at least 
through FY 1981. 

To retain "sufficiency" or "rough equivalency," a 7-percent in- 
crease in total obligational authority for FY 1977 is proposed. There 
is 14 percent real growth in strategic and general purpose forces 
because of the acquisition of many weapons to meet suspected threats. 

3 Central Intelligence Agency, "A Dollar Comparison of Soviet and U.S. 
Defense Activities, 1965-1975." SR 76-10053, February 1976. See also Central 
Intelligence Agency, "Estimated Soviet Defense Spending in Rubles, 1970- 
1975." SR 76-10121U, May 1976. 

4 Speech by Secretary of State Henry A. Kissinger, Boston, March 11, 1976. 


The overall defense budget projections for FY 1978 through FY 1981 
suggest at least 8 percent real growth during that period, approxi- 
mately the same as FY 1976 to FY 1977. The outyear impact of the 
FY 1977 program will probably result in another 10 to 15 percent 
real growth for strategic and general purpose forces in the FY 1978 
through FY 1981 time period. A 25- to 30-percent real growth in 
strategic and general purpose forces could thus be realized from FY 
1976 to FY 1981. 


To a considerable extent, FY 1977 budget decisions will largely 
determine the U.S. military force posture for the year 2000. Before 
committing the United States to such heavy spending, these questions 
need to be addressed: 

— To what extent is U.S. security to be denned in terms of the 
amount of military spending by our major adversary or by 
increased U.S.S.K. arms capability? 

— Are substantial increases required in the defense budget in 
FY 1977 through FY 1981 when the United States holds a 
qualitative lead in its strategic force and America's assured 
destruction capabilities are continually upgraded? 

— Because SALT-era decisions by the Soviet Union dealing with 
the deployment of new weapons are unknown, should the 
United States forge ahead with the deployment of a whole new 
generation of weapons? 

— Is not "sufficiency" a standard based on what the United States 
can do despite opposition from the U.S.S.R., not on what each 
side has and is building? 

— What defense posture can be achieved by percent, 1 percent, 
2 percent, 5 percent, or 10 percent real growth in strategic and 
general purpose forces in FY 1977? 

To sustain U.S. security, it is not clearly evident that world require- 
ments warrant growth of the size proposed in this and subsequent 
year budgets. 

//. Soviet Foreign /Military Policy 

Since the early 1960's, the Soviet Union has been modernizing and 
expanding its defense forces. The Brezhnev-headed team of new leader- 
ship which began its rule in 1964 made it national policy not only to 
continue increasing Russian military power, but to project that power 
to an extent far beyond that proposed by Stalin or Khrushchev. 
Beginning in 1968, U.S.S.R. defense spending began increasing at a 
rate of 2.7 percent per year. During this same period (with 1968 being 
the peak year of the American militar}^ effort in Vietnam), U.S. de- 
fense spending decreased. Only last year did the U.S. experience 
real growth in military spending, particularly for research and de- 
velopment and procurement purposes. Even more growth is proposed 
in FY 1977. 


Why has the Soviet Union chosen a course which steadily increases 
its spending for military forces and weaponry? What is the foreign 
policy rationale behind this effort? Has increased military spending 


been influenced by reasons of ideology or by perceptions of national 
interest or a combination of both? To what degree have U.S. policy 
decisions and actual weapons developments influenced Russian de- 
fense decisions? What bureaucratic forces are at work in Moscow 
which affect decisions regarding Soviet force deplo3onent? 

Interpreting the decisionmaking process within the Russian ruling 
elite is neither a sophisticated nor a well-advanced science. Indeed, it 
appears closer to a primitive art. Secrecy and Soviet propaganda 
shield the policy process from close scrutiny; a dearth of hard informa- 
tion exists. 

Soviet watchers in the governments of the NATO alliance, for in- 
stance, diligently study a variety of secret and open materials, but 
these materials are too frequently unrelated pieces of an incomplete 
puzzle and remain unlinked to the main issues. The analytical product, 
consequently, is admittedly imprecise. Interpretations of the rationale 
behind the Soviet Union's foreign/military thrust vary considerably, 
depending on one's view of the country's expansion-coexistence 
duality. Is the U.S.S.R. reacting primarily defensively in response to 
Chinese or NATO initiatives, or is the Soviet Union pursuing a long- 
term policy of eventual military dominance? 

Official and unofficial American interpretations show a significant 
lack of consensus about U.S.S.R. policy. Former Defense Secretary 
Melvin Laird has expressed the belief that increased Soviet military 
spending provides incontrovertible evidence that "The Soviet Union 
has engaged in a relentless effort to attain military supremacy." This 
view perceives the U.S.S.R. to be driven by its ideological mission to 
dominate. Secretary Kissinger regards the rise in defense spending on 
both sides to be more a result of bureaucratic politics, with the mili- 
tary services of both superpowers having an upper hand in determin- 
ing resource allocation. "My impression from what I have observed," 
Kissinger said at a July 3, 1974, press conference, is that both sets of 
civilian leadership "have to convince their military establishments of 
the benefits of restraint, and that is not a thought that comes naturally 
to military people on either side." Another important view attributes 
the steady rise of Soviet defense spending as a response to perceived 
security threats peculiar to the Soviet Union. 


Journalists and scholars who follow Soviet societ}' closely have 
portra}^ed a picture of subtlety and ambiguity. For instance, two new 
books on contemporary Russian life by correspondents Robert 
Kaiser of the Washington Post and Hedrick Smith of the New York 
Times provide impressions. 1 Both writers say the Soviet planned 
economy is sluggish; that it maintains a highly inefficient form of full 
employment; that Soviet industrial technology has been vastly 
overrated. Kaiser and Smith emphasize the country's development of 
computers is far behind the West's, and that its space accomplishments 
were more crude shadows than sophisticated substance. Kaiser argues 
that the Soviet Union's impressive economic growth statistics are 
essentially meaningless and have misled Western analysts into think- 
ing the country is more advanced than it actually is. Even Soviet 

1 Robert Kaiser, Russia: The People and the Power. New York, 1976; and 
Hedrick Smith, The Russians. New York, 1976. 


military strength, he adds, is misleading, for while it is now very real, 
it has come into being not as an outgrowth of technological strength 
but through sacrifice of potential economic vitality. Most Western 
analysts and observers share the view that the Soviets have over- 
committed resources to its defense sector. 2 

Soviet leadership admits giving the military top priority. Deputy 
Premier Nikolai K. Baibakov, chairman of the state planning com- 
mittee, recently spoke of the tenth 5-year plan's goals. The first 
priority, Baibakov said, was developing the economy, increasing 
production efficiency, and "strengthening the defense potential." 
Second was reinforcing the national economic base, raising technolog- 
ical standards, and improving the quality of output. Raising the 
people's living standards was listed third and last. 

This section of the spending study examines tendencies and trends 
in Moscow's foreign/military policy and the reasons for recent 
military development and deployment by the Soviet Union. The 
focus is on the external and internal factors giving impetus to increased 
defense spending. 


The Soviet security situation, over the course of the last 15 years, 
has shifted considerably. While concern about Western invasion by 
American-led NATO forces and possession of nuclear weapons by 
West Germany has abated, Soviet concerns now focus, ironically, on 
its socialist neighbor and former ally, China. At the 25th Congress of 
the CPSU, Brezhnev said, "Peking's frantic attempts to torpedo 
detente, to obstruct disarmament, to breed suspicion and hostility 
between states, its efforts to provoke a world war and reap whatever 
advantages may accrue, present a great danger." 


China is not a new security problem for the U.S.S.R. In the early 
1960's, Prof. Adam Ulam of Harvard University had written, "The 
problem of either containing China within the Communist camp or 
somehow expelling her has absorbed the Soviet policymakers to the 
point where other issues have become secondary." If the Kremlin 
were to confess what it undoubtedly feels, according to Ulam, it 
would say "that the major threat to the security of the Soviet Union 
is China and not the United States." 3 Behind this fear is the fact 
that Chinese missiles can now reach Moscow and other targets in 
European Russia. 

An October 1973 Pravda article admitted the Chinese had rejected 
the "confirmation of the validity of the Treaty of 1950." As the com- 
pact became void beginning in 1958, the Soviet Union chose to fortify 
the long and frequently forbidding 4, 000-mile Chinese border with 
Russian troops and armament added to the two divisions already 

2 The Economist of February 14, 1976 says of Brezhnev's Russia, "The renewed 
stress on heavy industry (including the defense industries) in the Five- Year 
Plan published last month is . . . depressing news for the Russian consumer." 
p. 02. 

3 Adam Ulam, Expansion and Coexistence: Soviet Foreign Policy, 1917-73. 
Second edition, New York, 1974, p. 678. 


stationed in Mongolia. Border clashes stimulated the buildup. In 
March 1969, a major engagement was fought between Chinese and 
Russian forces on Damansky Island. (A Chinese-based account was 
detailed in the London Observer of September 23, 1973, and it claimed 
a Soviet defeat.) A series of border incidents occurred through the 
summer of 1969. 

As a result, an extensive effort was made in moving Soviet troops 
eastward, adding to the two divisions already stationed in Mongolia. 
A new Central Asian military district was established, with responsi- 
bility for the Sinkiang border, and a missile specialist, Gen. V. F. 
Tolubko, was appointed to command the Far East military district. 
In September, Victor Louis, the renowned Soviet journalist, wrote 
about the danger of war, "The Soviet Union is adhering to the doctrine 
that socialist countries have the right to interfere in each other's 
affairs for their own interests or those of others who are threatened. " 
He said, "The fact that China is many times larger than Czechoslo- 
vakia and might offer active resistance is, according to Marxist 
theoreticians, no reason for not applying this docrtine." The Chinese 
replied with two nuclear tests in Sinkiang. At the end of 1972, another 
alleged clash took place on the Sino-Soviet border between Kazakh- 
stan and Sinkiang. It is reported that five Soviet guards were killed. 
In the 1970's, both countries have continuously waged psychological 
warfare as well. 


Since the late 1960's, the Russian Army has added 31 divisions to 
its military forces, 28 of which have gone to the Chinese border. A 
total of 43 divisions and two brigades are now deployed in Soviet 
Asia. It is important to note that this anti-Chinese buildup was 
accomplished without drawing down from any European-oriented 
forces. This involved additional extraordinary expenses. As section IV 
explains, they have also expanded air and missile forces east of the 
Urals. To support the anti-Chinese effort, extensive supply, mainte- 
nance, and reinforcement procedures have been developed in order to 
withstand Central Asian and Siberian weather and terrain conditions. 
In turn, China has built up a nu clear force dejrappe of 20 to 30 IRBMs 
and about 50 MRBMs deplo3^ed in northeastern China with range 
capabilities sufficient to reach Moscow and most Asian areas. 4 

The Sino-Soviet split has altered the traditional deployment pat- 
terns of the Soviet Army. No longer is the concentration Europe- 
oriented; it now comprises an emphasis on both Europe and Asia. 
The purpose of the 43 divisions and two brigades along or near China 
is disputed: Either they are positioned as a preliminary preparation 
for a Manchurian invasion or as a strike force designed to eliminate 
China's nuclear arrangements or possibly as Jeffrey Record, formerly 
of the Brookings Institution, has written, merely as "a garrison 
force . . . although the offensive combat power of Far Eastern 
deployment could be rapidly augmented should circumstances re- 
quire." 5 Judging from the U.S.S.R. 's hectic weapons program, there 

4 The International Institute for Strategic Studies. The Military Balance 
1975-1976. London, 1975, p. 49. It is reported in the June 14 Aviation Week & 
Space Technology that the "Soviet Union has moved part of a third tank division 
into the area around Bulgan, Mongolian People's Republic, about 500 miles from 
the Chinese border." 

6 Jeffrey Record. Sizing Up the Soviet Army. Washington, 1975, p. 19. 


is no question that Brezhnev's policy is to speak softly while earning 
big nuclear and conventional sticks which the Peking leadership must 
take into account. 


Another serious security situation which is of primary concern to 
Moscow is Eastern Europe. Czechoslovakia is the watchword. After 
the August 196S uprising in Prague, five Soviet Army divisions were 
sent to Czechoslovakia, which is where they currently remain. Other 
political disruptions have caused the Soviets to reinforce troops and 
armaments in East German}', Czechoslovakia, Poland, and Hungary, 
as well as in Western Russia. These concerns were (a) the 1970 workers 
uprising in Poland, (6) the independent foreign policies pursued by 
Romania, Yugoslavia, and Albania, resulting in a virulent 1971 press 
campaign accusing these three governments of forming an "anti- 
Soviet axis," and (c) the deep Soviet fear of the domino theory in its 
own sphere of influence. A total of 31 motorized and armored U.S.S.R. 
divisions reside in Eastern Europe. 

Moscow saw the course of "liberalizing" events in Czechoslovakia in 
1967 and 1968 as a threat to the stability of other Communist regimes 
in Eastern Europe and, according to some observers, not inconceivable- 
led to disturbing reverberations within the U.S.S.R. itself. When the 
invasion occurred, the Soviets had explored the situation well enough 
in advance to know the Red Arm}- would not be met with armed 
resistance. Four hundred thousand Warsaw Pact soldiers, over- 
whelmingly Soviet, seized a country of 14 million people. 

In Poland, the Soviet Army was on the brink of intervention around 
Christmas 1970 when workers concentrated in the maritime provinces 
responded to food price rises by storming Communist Party head- 
quarters. It is reported casualties were sizeable. The crisis was allayed 
when Gomukla was removed, his subordinates demoted, and Edward 
Gierek, the new premier, rescinded the price increases and personally 
visited the troubled area. In Eastern Europe, the Soviet Union, by its 
"anxious authoritarianism," has made it clear that it is determined to 
preserve socialist society against local nationalisms and anything 
new in Marxist thought and is determined not to permit further 
loosening of the bonds that hold the socialist camp together. 6 This 
includes the proximity of force in case the spirit of cooperation with 
Western Europe and the United States becomes more tangible in this 
volatile area. 


With regard to security relations with the United States, the Soviet 
Union foreign/military policy goals are complex and ambivalent. 
Since the October 1962 Cuban missile crisis, the Soviets have traveled 
two roads, increasing the number of their own strategic nuclear weap- 
pons while seeking agreements on general limitations and on non- 
proliferation of nuclear powers. 

Kremlin policymakers have aspired to nuclear parity with the 
United States. Achieving this parity has been the greatest accomplish- 
ment of Brezhnev's period of rule. Today the Soviet Union is uni- 
versally acknowledged to be a superpower. (But the word superpower 

•Thomas W. Wolfe,Soviet Power and Europe, 1945-1970. Baltimore, 1970 
p. 404. 


is not part of the Soviet vocabularly. When it is used, it appears in 
inverted commas. In the official History of Soviet Foreign Policy, 
the Soviet Union is described as "one of the greatest world powers, 
without whose participation not a single international problem can be 
solved." Brezhnev, for instance, in Washington in his June 1973 
meeting with Senators, brushed the term superpower aside. A partial 
reason for such modesty is the pejorative significance the term has 
acquired in China's political vocabulary-; the Chinese disclaim any 
intention of aspiring to superpower status themselves.) 


The U.S. and U.S.S.R. have established a situation of mutual de- 
terrence. For the Soviet Union, as for the United States, the prospect 
of nuclear exchange against a power capable of massive retaliation 
by vast numbers of weapons from under the sea, from land, and from 
the air, poses unacceptable risks. So now the Soviets seem to be 
playing the strategy of deterrence. Moscow has the arsenal to threaten 
its opponent with such severe retaliation for an attack that they as- 
sume the rationally calculating United States will choose not to 
initiate an attack. Such a large negative payoff is now a reality. But, 
the fact the U.S.S.R. rejects the actual use of nuclear weapons does 
not preclude their using them as a bargaining card at the conference 
table. The Soviets raise the question: Would Washington, while facing 
a crisis like that of the Cuban missile showdown, behave the way it 
did then if it knew Soviet nuclear power was now roughly equal to 
its own? The United States raises the converse question. In the 1972 
arms control agreements between the U.S. and U.S.S.R., the United 
States sought to stabilize the present level of the two powers' nuclear 
arsenals. SALT I enabled each side to proclaim that it had achieved 
its aim: Russia had reached at least parity with the United States; 
America had preserved its lead. The same face-saving formula holds 
for the Vladivostok guidelines and the thrust of the SALT II agree- 
ments and disagreements. 

Another angle to the Kremlin Westpolitik policy with the United 
States and West Germany is not to appear too much the supplicant. 
In this regard, Brezhnev's attitude toward projecting a stance of 
strength is similar to that of Khrushchev, who in December 1961 
acknowledged in a public speech, "If you and I come up to the im- 
perialists carrying a cross and praying, and on our knees begin to 
implore them to be humane, they would laugh at us, they would see 
in this our weakness and their strength." 

Professor Ulam has interpreted this Russian thought process in the 
following way : Brezhnev and the others ' 'have been only too conscious 
that any friendly overture (detente) on their part would be interpreted 
in the West as due to Moscow's fear of China and/or serious domestic 
troubles within the U.S.S.R. And so, while seeking a detente, the 
Soviet Union would not appear to be pleading for it, would never 
appear to be negotiating out of fear, rather than in pursuance of the 
immutable goals of Soviet foreign policy." 7 Despite the appearance 
of power, the rapid Soviet nuclear stockpile buildup and development 
of sophisticated delivery systems in the 1960's and 1970's can be un- 
derstood on\y partially as the result of the Soviet's desire to reduce 

7 Ulam, op. cit.j p. 749. 
72-678—76 10 


America's superior position, but more urgently as an expression of their 
need to establish a crushing superiority over China's evolving nuclear 

Brezhnev and his successors clearly will not settle for less than nuclear 
parity. It has become the Soviet national interest to preserve a strate- 
gic balance with the United States. The paradox of this balance is 
that it now places on the shoulders of the Soviet Union, as it already 
has on the United States, a serious consequence. Even under tech- 
nologically stable conditions of mutual deterrence, there is no limit 
to strategic arms research and development, and deployments not 
limited by SALT. In fact, if both countries were to undertake a con- 
tinuous search for qualitative improvements in their nuclear forces 
and otherwise hedge against the threat of the other, a series of in- 
teractive deployments could occur, driving both sides to higher levels 
of potential destructiveness until constraining symmetrical agree- 
ments are reached. 


General purpose forces are another element of the Soviet military 
growth. The increase is related not only to offsetting China and NATO 
and snuffing out liberal movements in Eastern Europe, but also to a 
strategy aimed at the Third World. There are two main military 
prerequisites which determine the credibility and the effects of foreign 
policy commitments. The first is the nation's ability to provide suffi- 
cient military support to fulfill pledges made. The second is the aware- 
ness of others of its willingness to provide such support. Until the mid- 
1960's, the Soviet Union lacked the capacity to intervene effectively 
in areas outside its adjacent environment as the Guinea, Ghana, and 
Congo episodes demonstrated. But once the United States intensified 
its intervention in Vietnam and became mired down in that expanded 
affair, unable to win the war and unable to cut its losses and extricate 
itself fully until the spring of 1975, opportunities arose for advancing 
Soviet influence in many parts of the world. Ironically, this was helped 
along by the passing in 1967 of the danger of a Soviet-American 
confrontation over Vietnam. Since then, however, the Vietnam im- 
passe reduced Washington's ability and the American people's 
willingness to counter Soviet moves in places like Egypt, Syria, 
Nigeria, Somalia, Angola, and Communist Party efforts in Portugal 
and Italy. 

In order to intervene in areas not adjacent to its borders, the Soviet 
Union has begun to develop weapons suitable for the circumstances. 
For instance, in the late 1960's, part of the motivation behind the 
expansion of the Soviet naval building program was force projection. 
Surface ships like helicopter carriers — although these primarily have 
an anti-submarine warfare (ASW) mission — and amphibious marine 
landing capabilities were emphasized. Moscow's rationale is obvious: 
In a crisis the salvation of some pro-Soviet regime may depend on a 
speedy landing and intervention. In 1967, an all-jet Soviet vertical 
takeoff and land (VTOL) fighter was unveiled; an advanced version 
is now assigned to the helicopter earners. As the Yom Kippur War 
and the Angolan situation showed, the Soviets have a new airlift 
ability. The extensive utilization of helicopter strength and the giant- 
AN-22 transports allow for much greater mobility. 


In addition to international concerns affecting Soviet perceptions 
of needs, there are forces at work internally influencing Soviet mili- 
tary spending. 


Institutional forces have affected Soviet decisions regarding the 
size of the Soviet armed forces. During the Stalinist period, arms policy 
was constrained by traditional military thinking, emphasizing de- 
fensive forces. The intensive increase began at the end of the dictator's 
reign. In the mid-1 950's, the technological missile and rocketry base 
was established. The Soviet IS avy started slowly, eventually expanding 
from an offshore fleet of land-oriented power into an oceanic fleet 
befitting a major maritime power. The Sputnik success highlighted a 
period of initial long-range missile development covering the years 
1958 through 1961. Assured second-strike forces were developed from 
1962 through 1966 and, to the present time, both counterforce capa- 
bilities and a global Navy emerged to challenge the United States 
and to permit and bolster intervention in countries far from the 
Soviet Union. During these periods of military development, institu- 
tional forces were at work inside the Soviet Union, affecting decisions 
to spend more on the military and its related programs. 


The nuclear "action-reaction" phenomena in both the U.S. and 
U.S.S.R. has been documented. 8 It is clear the United States will 
militarily match its major adversary. It appears the Soviet decision 
to match America's capabilities and operational flexibility occurred 
in 1966, as witness the great missile procurement increments and 
increased military budgets. By the end of the decade, Soviet ministry 
of defense authorities were insisting strategic superiority had been 
achieved, and that it must be retained. 

The "action-reaction" process also motivated the Soviet's general 
purpose forces development. It provided military officials a reasonable 
basis within the bureaucracy to advance particular programs. Several 
Soviet military leaders in 1965, for instance, stressed the need for 
greater flexibility and improved quality of military doctrine. They 
focused not only on having forces directed against forces of the ad- 
versary, but on matching the combat ieadiness and deployment spread 
of NATO, too. NATO's asserted peacetime deployment of forces in 
the right places, NATO numbers, and proportions for the achievement 
"of its main war tasks in the short period" were held up for emulation. 
Similarly, the sinking of the Israeli ship Eilat in the June 1967 war 
by a missile from an Egyptian-manned Komar-class patrol boat 

8 G. W. Rathjens, "The Dynamics of the Arms Race," Scientific American, 
April 1959; Herb York, Race to Oblivion. New York, 1970. Wolfgang 
K. H. Panofsky, "The Mutual Hostage Relationship Between America and 
Russia," Foreign Affairs, October 1973; Jerome H. Kahan, Security in the Nuclear 
Aqe. Washington, 1975; and John Steinbruner, "Beyond Rational Deterrence," 
World Politics, January 1976. The phenomena has been debunked by T. W. Wolfe 
and Fritz Ermath in their paper entitled "Interaction Process and Its Influence 
on Major Soviet Arms Decisions." (U) Rand Corporation, Rl ISO-PR, August 
1971 (S) and by J. H. Depres in his memorandum "Russo- American Strategic 
Interaction: Military Budgets." (U) Rand Corporation, RM7447-PR, 1971 (S). 
See also two articles by Albert Wohlstetter, "Is There a Strategic Arms Race?" 
in Foreign Policy, Summer 1974 and Fall 1974. 


spurred NATO efforts to develop comparable weaponry for member 
navies. The Norwegian Penguin, the French Exocet, and the American 
Harpoon were the result. 

Another influence on the size of the Soviet defense budget and the 
expansion of military programs is the prominence given to the armed 
forres by Brezhnev. In 1964, the new leadership lost little time in as- 
suring the military that the party held them in high esteem. Since then, 
the regime has stressed the autonomy and specialized nature of the 
military. The amorphous "Stalingrad group" has retained its hold on 
policy-influencing positions, but younger men have been promoted 
at an unusually high, although erratic, rate. These promotions have 
been based on the individual's experience with conventional and non- 
conventional weaponry: the trend is toward great specialization, pro- 
viding for integration of nuclear and conventional specializations. Not 
only have younger men been promoted to commands (a large percent- 
age of prominent incumbents in 1972, for instance, were under 60 
years old, slightly less in the 50 to 55 age bracket, and some were 
even in their 40's), they also gained access to the highest policy coun- 
cils. As professionalism increased, a basic comparability of party and 
military aspirations increased, and most problems pertaining to mili- 
tant issues and policy are left to Frunze Street. As the 25th Soviet 
Communist Party Congress makes clear, however, political and eco- 
nomic authority continues to be jealously held by the civilian leader- 


Another element here is the close, personal links Brezhnev has had 
with military men throughout his political career. During the Second 
World War, as political commissar of the Soviet 18th Army, he began 
his long friendship with Gen. Andrei Grechko; on April 12, 1967, 12 
days after Malinovsky died, Marshal Grechko became Brezhnev's 
defense minister. Other wartime and political colleagues now in key 
portions are Adm. Sergei Gorshkov, commander in chief of the 
Soviet Navy; Gen. Viktor Kulikov, chief of the Soviet armed forces 
general staff and a first deputy defense minister; Marshal Kirill S. 
Moskalenko, another deputy defense minister and presently the chief 
of the main inspectorate of the Soviet armed forces; Gen. Sergei 
Shtomenko, whom Khrushchev had demoted, was returned to rank 
and authority by Brezhnev and made chief of staff for Warsaw Pact 
forces (Shtemenko died this spring but has not yet been replaced); 
until his death in 1970, Marshal And rev Veremenko served as in- 
spector genera] of the Soviet defense ministry; Gen. Ivan G. Pavlov- 
skiy, also a deputy minister of defense and commander-in-chief of 
Soviet land forces (Pavlovsky commanded the units that invaded 
Czechoslovakia in 1968); Gen. Nikolai Lyaskchenko is Central Asian 
military district commander; Col. Gen. Anton I. Gastilovich is deputy 
head of the Soviet general staff academy; Col. Gen. Konstantin 
Gruskevoi is political commissar of Moscow military district; Lt. 
Gen. Nikita S. Demin is deputy chairman of civilian "volunteer 
assistants of the army, air force, and navy" (DOSAAF), a para- 
military and pre-military training organization; and Gen. Aleksei A. 
Yepi-hev is ehief political commissar of the Soviet Army and Navy 
and a chief link for Brezhnev to the high command. In 1971, 20 high 
ranking military officers achieved full membership of the central 


committee and, of these, seven are close political allies of the secretary 
general. 9 


Prof. Marshall D. Shulman of Columbia University has written a 
detailed description of the Soviet decisionmaking process on SALT 
matters which shows the military's present predominance in strategic 
issues, a process John Newhouse also documented in his book Cold 
Dawn about the SALT I negotiations. Shulman's description also 
notes the difference between decisionmaking in Washington and 
Moscow. He writes: 

There is no Soviet analogue to the U.S. Arms Control and 
Disarmament Agenc3 r ; no precise analogue to the National 
Security Council and its staff; and no circulation of defense 
scientists in and out of government, as in the United States, 
to provide an independent lobby and public debates on 
arms control issues. The Supreme Soviet, the legislative 
arm of government, does have standing commissions on 
foreign policy, which approved the first SALT Treaty, but 
in the Soviet system there is no equivalent to congressional 
committee hearings, which are independent of and often 
critical of the administration position during the period 
when decisions are being made. In the Soviet Union, the 
militant play a larger role in originating positions on SALT 
than in the United States. The main locus of work on the 
preparation of positions for SALT is to be found in the 
Soviet ministnr of defense, which has a section charged 
with this responsibility, under the general staff. Although the 
Soviet ministr}^ of foreign affairs is involved in the process, 
its role is largely limited to the diplomatic and political 
aspects of the negotiations, and it is kept out of the technical 
hardware details of arms limitation problems. Between the 
ministiy of defense and the party leadership are a number of 
important mechanisms for coordinating military policy 
with political and economic considerations, including the 
military council, on which Brezhnev sits as chairman, and 
the military industrial commission, which oversees the 
Soviet armament industry. The Soviet penchant for extreme 
secrecy on military matters has restricted technical informa- 
tion on arms control issues to a small circle within the 
Soviet military establishment, although the effects of sum- 
mit meetings on SALT may have widened the circle of 
party and government officials who are informed and in- 
volved in arms limitation matters. 10 

9 John Dornberg, Brezhnev: The Masks of Power. New York, 1974. For a view 
of the c?ntral role of the party chief and the party in military policy formula- 
tion, especially Brezhnev as a "Bonaparte" in the Soviet system, see William E. 
Odom, "Who Controls Whom in Moscow," Foreign Policy, Summer 1975. 

10 Marshall D. Shulman, "SALT: Through the Looking Glass." Arms Control 
Today, February 1975. 



An analysis of Soviet military considerations affecting: national 
policymaking written by Dr. Carl G. Jacobsen formerly of Harvard 
University contends, "Although the armed forces constitute only 
one of the policy-effecting instruments of the political leadership, the 
armed forces establishment is integrated into this political leadership 
to an extent which entails considerable influence on the choice of 
instruments." This influence extends to the economy. For example, 
at the 24th CPSU Congress in 1971, Brezhnev acknowledged that 
". . . 42 percent of (the defense industry's) output is used for civilian 
purposes." The significance of this figure is also reflected in the priv- 
ileged position of the defense's recruitment of scientists, the produc- 
tive capacity of these industries, and the state of military/civilian 
integration. In that same speech, Brezhnev justified increased mili- 
tary spending because of the increasing American commitment to 
the Indochina war and to China's anti-Moscow bellicosity. 11 

One result after a decade of Soviet military self-oversight is the 
lavish display of procurement. And the institutional momentum 
continues today. This level of military activity, of course, injects a 
large degree of uncertainty into any analysis of the relationship 
between increased military spending and Soviet ideology and national 

Another situation putting pressure on the Soviet military budget is 
the enlargement of para-military forces maintained primarily for 
internal security purposes. The KGB border guards and MVD 
security troops have grown substantially in recent years. The dis- 
sident voices of intellectuals and religious groups coupled with activi- 
ties against Brezhnev by part}^ members Shelepin (over ambition), 
Suslov (over Czechoslovakia), and Shelest (over Westpolitik), caused 
the leadership to exert more stringent and security-conscious controls 
on its own citizens. To this end, the home guard was instituted, armed 
and trained. With the onset of detente externally, increased repres- 
sive measures were taken internal!}'. 


Viewed as a whole, the U.S.S.R.'s armed forces have expanded in 
recent years to provide a "visibly increased preponderance," to use 
Foreign Minister Gromyko's phrase, behind the country's foreign/ 
military policy. The reasons for this military expansion are mainly 
based on the peculiar international and internal security situation the 
Soviet Union currently perceives it faces plus the psychological sense 
the leadership has of the country's role in world affairs. As a result, 
there is now a symmetry in the U.S./U.S.S.R. military balance and a 
shift of the Soviet Union from a continental power to a country with 
the modest capacity to intervene locally in contested trouble spots or 
create some of its own on faraway continents. Whether this military 
buildup will persist is unclear. 

The forces in the field today are the result of decisions made before 
the Brezhnev policy of detente was enacted in 1972. The SALT-era 
decisions dealing with the deployment of new weapons are an unknown. 

11 C. G. Jackson, Soviet Strategy-Soviet Foreign Policy: Military Considerations 
Affecting Soviet Policy- Making. Glasgow, 1974. 


///. Usefulness of U.S./U.S.S.R. Military Spending Comparisons 

In analyzing the force balance between the U.S. and the U.S.S.R., 
are comparisons of military. spending useful? 

It is argued that such comparisons (a) can show the relative size of 
the effort devoted by each side to producing and maintaining military 
power; (b) provide clues to the intentions of each side; and (c) indicate 
a trend in relative military capability. 

Spending comparisons serve to aggregate a very large number of dif- 
ferent elements supporting military power into simple and apparently 
comprehensive sets of numbers. But if the forces and activities on 
both sides are given common weighting factors — prices, in effect — 
and the products aggregated, the resulting sums can be compared. 
Relative size and trends are immediately apparent. And since the 
weighting factors are money valuations, and most people believe they 
know the value of money, the resultant numbers have an appealing 
"feel" of reality. 

Other uses of spending comparisons are thought to include helping 
to make judgments about the relative burden of military expenditures 
on the economies of rival states, about the efficiency with which rivals 
convert resources into military force, or about the real nature of 
crucial military balances. 1 Whether presently available spending com- 
parisons are appropriate to these uses is a technical question to be 
taken up later in this section. But there can be little doubt that we 
would like to have a clearer understanding of these questions of 
burden, efficiency, and balance, and that the costs of the forces in 
question are relevant to these issues. 


The usefulness of cost comparisons as measurements of resource 
inputs to military forces has been challenged by Lt. Gen. Daniel 
Graham, retired former Director of the Defense Intelligence Agenc} 7 . 
Graham expressed skepticism about the usefulness and validity, 
particularly of dollar costing, a technique that will be explained later 
in this section of the study. His reasons for such skepticism are based 
on his 3^ears of close association with intelligence on Soviet military 
programs. He was unable to believe that the very large increases in 
Soviet military forces, programs, and activities which he observed 
during that period were adequately reflected in the very slowly rising 
CIA cost figures covering the period. Graham testified before the 
Joint Economic Committee Subcommittee on Priorities and Economy 
in Government that, "As to dollar presentations, I will probably 
retain my basic distrust of results. They are simply misleading." 
While it is not completely clear from Graham's testimony whether he 
believes there might be a right way to do dollar costing and, if so, 
whether he thinks the result would be useful, there is a hint that he 
considers the problem to be fundamentally methodological. He stated, 

1 For example, the famous "PEMA-People Paradox" by Alain Enthoven and 
Wayne Smith, How Much Is Enough? Shaping the Defense Program 1961-1969, 
New York, 1971. The gist of the paradox is as follows: "The Warsaw Pact had 
overwhelming ground force strength in Europe, even though they have onVy 
slightly more men under arms than NATO, and spend about the same amount 
■on their equipment, operations, and maintenance." 


for example ". . . I doubt that the Soviets, with full access to the 
data denied to us, could produce a valid dollar value of their defense 
efforts." This seems to imply a view that the problem is exceedingly 
difficult, but not, in principle, impossible. 


Other observers appear to believe that cost comparisons could be 
useful if properly done. Andrew W. Marshall, Director of Net Assess- 
ment, Office of the Secretary of Defense, in a letter submitted to the 
Subcommittee on Priorities and Economy in Government for its 
hearings, wrote, "Properly conceived and executed analyses of 
comparative U.S. and Soviet defense expenditures can provide 
valuable insights into the status and trends of the two defense efforts." 
An enclosure to the letter is an extremely thorough and competent 
treatment of the technical problems involved in making cost compari- 
sons, which concludes, among other things, "On balance, the current 
estimates tend to underestimate the size of the Soviet activity relative 
to U.S. defense expenditures. Little confidence is held, therefore, 
in the absolute magnitude of the Soviet dollar figure specified by the 
CIA documents." 

In contrast to those who would concede some usefulness to cost 
comparisons, if properly done, are those who argue that such com- 
parisons are irrelevant. This line of argument goes as follows: "It 
doesn't matter what the other side pa}^s for its military forces. It is 
irrelevant. The real problem is how best to provide a countervailing 
military capability and that is an internal resource allocation problem 
unaffected by considerations of the costs the other side incurs." 

Thus, we confront two differing interpretations regarding cost 
comparisons: Those who think they could be useful, if properly done, 
and those who think even theoretically impeccable estimates would 
not be relevant to the questions they purport to address. 


Before discussing cost comparison methodologies and attempting 
to clarify the question of relevance, it is most important to stress that 
they are extremely complex technical exercises, and that argument 
about the details of costing or possible systematic bias in the com- 
parisons are likely to be distracting and hence counterproductive. 
This is because a lot of the methodological problems are insoluble 
and others, given the massive number of individual calculations, 
each requiring assumptions, estimates, and approximations, are 
extremely uncertain as to their effect. Arguments over these points 
can go on at great length without reaching a conclusion. 


The technique by which dollar costing of Soviet military programs 
is pursued involves two steps: (1) cataloging all of the items involved 
in those programs; and (2) imputing a dollar cost to each. The cata- 
loging involves counts of observables, such as army divisions, ships, 
aircraft, tanks, and so on. Many different intelligence-gathering 
techniques are required to make such counts, and where intelligence 
gaps exist, estimates of such items, the correct numbers, tempo of 
operations, logistics support, manning, and so forth must be made. 


A large number of individual elements counted or assumed, and the 
uncertainty which accompanies the aggregation of catalog estimates 
can be quite large. 

Imputation of dollar costs is a similarly complex and difficult task. 
On the surface it sounds simple: One simply estimates the cost of 
reproducing the item in the United States. This, however, soon proves 
more difficult than one might think. Where there are direct military 
analogues, for example, tanks of similar size, armor, and firepower, 
the cost of the Soviet system is taken directly as the cost of the similar 
U.S. system. Where there are no closely similar U.S. systems to Soviet 
systems, estimates must be made by U.S. cost estimators based on 
the observed or assumed characteristics of the Soviet system. The 
cost estimating relationships used in such estimates are usually those 
appropriate to U.S. industrial practice in the U.S. economy. They do 
not usually take account, for example, of Soviet propensities toward 
simpler and more rugged machinery, or toward standardization. 2 On 
occasion, where some well-known Soviet practice has a clearly identi- 
fiable impact on costs, the estimates are adjusted to accommodate 

Marshall, in his paper referred to above, pointed out a specific 
problem with the costing of Soviet militan T manpower. The CIA's 
method of costing manpower is to derive an average U.S. cost-per- 
man by dividing the total manpower costs, including pay, allowances, 
and subsistence of a particular service by the total manpower in the 
service. This factor is, in turn, multiplied by the total manpower 
in the appropriate Soviet service to derive a total dollar cost. One of 
the problems with this, as Marshall pointed out, is that it assumes 
the grade and pay structure of the Soviet service is the same as that 
of its equivalent U.S. service — an unlikely assumption. 


Ruble costing of Soviet defense programs involves much of the 
same kind of estimating process as the dollar costing. Ruble prices 
are available for many of the items in Soviet military programs, such 
as pa}' to individuals and items that are much the same as other items 
in the civilian economy, such as trucks. Ruble prices for Soviet 
weapons systems are not, however, available in the open literature. 
For such systems, what is common]}' done is to make a dollar cost 
estimate, and then convert this to rubles by using a ruble-to-dollar 
conversion ratio based on a similar exchange ratio; e.g. for a tank, one 
might use what is known for tractors. 

As the preceding brief discussion makes clear, there is a very large 
element of estimation in any of the cost comparison methodologies, 
and hence a large amount of uncertainty. Further, since the method 
used to make cost estimates frequently depends on available informa- 
tion, the basis of the estimates may change over time as more informa- 
tion becomes available or as sources of information are closed to us. 

There is a final theoretical point to be made about cost comparisons 
of activities in different economies. The method of constructing the 

2 For example, it is reported that the diesel engine used in the Soviet T-54 tank 
is essentially the engine that has been in serial production in the U.S.S.R. since the 


aggregated defense costs resembles the method of construction of 
index numbers used for economic comparisons across time. It suffers 
from the same theoretical deficiency that index numbers do. That is, 
the evaluation of a collection of goods in one period by the prices 
prevailing in another does not exactly reflect its real value in either 
period, because there is no opportunity to change the mix of goods 
in response to changing relative prices between the periods. Given 
that relative prices do change between periods, the index number 
always overstates the value of one period's goods in another period's 
prices. Applied to spending comparisons, this means that dollar 
costing of Soviet programs, or ruble costing of U.S. programs tends 
to overstate the costs of both. A brief example may help clarify this. 
For the United States to attempt to duplicate a Soviet missile capa- 
bility by making a "Chinese-copy" of a Soviet missile would be a very 
expensive undertaking, because U.S. industry and engineering just 
do not do things the way the Soviets do, and a lot of changing around 
and nonstandard practice would accompany such an undertaking. 
It would be cheaper to replicate the capability of the Soviet missile 
using the design and fabrication practices common in this country. 
But the point of this example is that Soviet practice is cheaper in the 
U.S.S.R. and U.S. practice cheaper in the United States because 
in both cases people have proceeded in ways to minimize their own 
cosisj and these are different ways. 

In summary, with respect to methodologies, there are theoretical 
reasons to think that cost comparisons between different economies 
are biased and there are practical reasons for thinking that there is 
considerable uncertainty in the CIA aggregated dollar cost and ruble 
cost estimates. 


Even if accurate, unbiased, and credible cost comparisons could be 
made between U.S. and Soviet military programs, would they be 
useful? To put the point another way, would it matter if one side 
were out spending the other on military forces? Clearly, the answer 
depends on what each side is obtaining from its resource inputs. What 
is important about military forces is certainly much more than their 
ability to absorb resources. Senator Proxmire has recentty suggested 
that an explanation of estimated increased Soviet military spending 
is that the Soviets are learning to waste money on military programs 
at a much greater rate. What is meant by waste in this context should, 
perhaps, be the subject of another paper. But the important point is 
to be concerned with the relevant outputs. 

One form of military output loosely linked to the input comparisons 
and size comparisons is the impact on the perceptions of adversaries 
and allies of one's military programs. It is how tough we appear; how 
much we reassure our friends; how much we deter our adversaries 
from testing us. This kind of military output has both political utility 
and drawbacks, and is certainly related to how much effort (money) 
we put into military programs, and how big our apparent forces are. 
It is perhaps less important in this regard that our apparent forces 
have a high degree of readiness, or have really competent, survivable 
weapons systems in real battle environments. 

Another form of military output is generally termed "capability. " 
It is the capacity to destroy enemy forces, defend friendly territory 
and forces, and generally to win military engagements. Calculating 


such capability is a complex technical task which requires a host of 
assumptions about the engagement scenarios, characteristics of oppos- 
ing systems, and many other things. However, it is this form of mili- 
tary "output that man}^ people think of in relation to money spent on 
military programs. But here the link between resource inputs and ap- 
propriate outputs is even more tenuous. 


Whether or not spending comparisons are relevant to discussions 
about how much to spend probably depends in the short run upon 
whether one is more concerned with perceptions and the political use of 
military forces, or with issues of real military capability. In the longer 
run these issues converge and thus credible spending comparisons can 
be useful in assessing trends in real military capabilit}^ as well as in 
resolve and determination not to be second best. If one side puts more 
resources than the other into military programs consistently 6'veiS a 
period of years, it is difficult to escape the conclusion that the first 
side will eventually accumulate a preponderant fflSitary capability. 
Such a military capability may still not give the first side a free hand 
in imposing its will on the other. The usefulness of military preponder- 
ance can have severe limitations. The significance of military supe- 
riority or inferiority is presumably an issue which is capable of being 
analyzed and settled on its own merits. To put the point another way, 
spending comparisons are not Iikeh T to be useful in predicting what 
happens as the result of one side or another achieving a lead in military 

There is considerable uncertainty about whether the costing 
methodologies presently in use to compare military spending in the 
U.S. and U.S.S.R. will support conclusions, at least in the short run, 
about the status and trends in real military capabilities between the 
two countries. There is difference of opinion about whether spending 
levels would be relevant measures even if the costing methodologies 
were credible. This leads to the conclusion that cost comparisons must 
be used with great care and discrimination in arguing appropriate 
policy options. At the least, such comparisons should be given context 
by reference to appropriate military outputs, and by reference to 
observable forces and activities of the U.S.S.R. As Marshall 
observes, . . . the policy issue to which sizing analyses are directed 
would be better served if several complementary estimates of Soviet 
activity were available and appropriately documented. " 


Finally, the foregoing discussion prompts the observation that the 
tendency to compare inputs to military programs between the U.S. 
and U.S.S.R. in addressing policy questions may beg a more funda- 
mental question. That is, what sort of capabilities does the United 
States require to defend itself and its allies, and to cany out its 
foreign policy? Should we assume that required capabilities must be 
attained by matching inputs with our adversaries, or should we tailor 
our programs to provide specific outputs where we perceive the need 
for them? 


IV. U.S./U,S>S.R. Quantitative Force Comparisons: Cost 
Implications for Fiscal Year 1977 Budget 

Over the past 15 to 17 years, the U.S.S.R. has been committed to a 
policy of upgrading its military forces and firepower to achieve parity 
with the United States in commonly accepted measures of global 
power. The Soviet Union, through concentration and steady growth 
in defense expenditures, has advanced its technology for military 
purposes. Consequently, U.S. superiority in strategic forces which 
was unquestioned during the 1960's has been challenged by the 
U.S.S.R. in the 1970's. 


The overall strategic balance remains in favor of the United States. 
Because of America's capacity to inflict unacceptable damage on the 
U.S.S.R., and the uncertainty of the outcome of even limited military 
provocations, the Soviet Union is deterred from initiating hostile 
military action. 

The proposed programs in the FY 1977 defense budget indicate 
the preferred direction of the Administration for U.S. military posture 
through the end of the 20th century. The recommended strategic 
and general purpose force strengths, when added to existing United 
States and allied force power, are intended to solidify NATO capa- 
bility to defend against the Soviet Union and its allies 


Many welcomed the SALT agreements as a positive if not conclusive 
means of constraining the nuclear arms competition. Yet, since June 
1972, both sides have improved the quality of their strategic systems, 
and the U.S.S.R. has continued to develop and deploy (a) a wide 
variety of ballistic missiles., (6) the Backfire bomber, and (c) assorted 
ships for an enhanced naval capability. 

In the general purpose forces realm, the Soviet Union has expanded 
its force levels and added new equipment, especially tactical aircraft, 
artillery, and navy ships. Much of the new land and tactical air force 
strength has been deployed to the Sino-Soviet border to face the 
Chinese. At the same time, the Soviet Union's western-oriented forces 
have improved in terms of size and sophistication. The Soviet Navy is 
now capable of operating worldwide. 


The following force assessment of the military balance between the 
U.S. and U.S.S.R. focuses on the quantitative comparisons of men 
and equipment and the positioning of present NATO and Warsaw 
Pact forces. Major U.S. programs and costs proposed in the FY 1977 
budget are identified within each mission area of strategic and general 
purpose forces. Further, the outyear implications resulting from FY 
1977 budget proposals are also identified. No attempt is made to 
address the quality of forces. Not only is there difficulty in addressing 
such values, but the variables of conflict could render such compari- 


sons invalid. The amounts indicated herein reflect the January 1976 
budget request and do not include figures for subsequent budget 




States U.S.S.R. 

Intercontinental ballistic missiles (ICBMs) 1,054 1,600 

Submarine-launched ballistic missiles (SLBMs) 656 730 

Total missile launchers 1,710 2,330 

Intercontinental bombers 1 500 160 

Total delivery vehicles 2 2,210 2 , 490 

Total multiple independently targetable reentry 

launchers (MIRV launchers) +925 110 

1 Includes deployed, strike-configured operational aircraft only. 

2 The total throw-weight of the delivery vehicles is approximately the same for 
both nations. The U.S.S.R. holds a sizeable lead in missile throw- weight which is 
offset by the U.S. lead in bomber payload capability. Throw-weight is defined as 
weight of missile above last boost stage with projected or programed configurations 
1,000's of pounds. Bomber payload is 1,000's of pounds representative aircraft 
loading rather than maximum or worst case. 





Warheads and bombs : 

1972 2 


5, 600 

8, 500 

2, 200 
2, 500 

1 Online. 

2 Year of SALT I agreement. 

Intercontinental Ballistic Missiles (ICBMs) 

Soviet ICBM programs center around the older SS-7, SS-8, SS-9, 
SS-11, and SS-13 systems, many of which will probably be phased 
out during the next decade and replaced by the SS-X-16, SS-17, 
SS-18, and SS-19. The new ICBM family offers significant growth 
in target accuracy and multiple independently targetable reentry 
vehicle (MIRV) capability. There are indications that testing has 
been conducted on a land-based mobile capability for the SS-X-16; 
however, deployment in the near future appears unlikely. 

U.S. ICBM programs are the Titan II (54), Minuteman II (450) 
and Minuteman III (550) missiles. Major development efforts in the 
DoD FY 1977 budget associated with the ICBM program are: 
(a) Minuteman (silo hardening, guidance, and target accuracy im- 
provement), (6) M-X missile (advanced development of a new 
ICBM and mobile basing options), and (c) advanced ballistic reentry 
systems capability (ABRES). The costs for these efforts are: 



[In millions of dollars] 

and prior 

FY 76 

FY 77 


FY 81 







(804. 1) 
(36. 0) 
(90. 8) 

471. 6 

601. 3 
1 184. 
1 117. 

214. 8 

( 2 ) 
( 3 ) 

12, 738. 1 

( 2 ) 
( 3 ) 

1 Fiscal year 1978. 

2 To be determined. 

3 Continuing development. 

Submarine-Launched Ballistic Missiles (SLBMs) 

Soviet SLBMs currently in the force are the SS-N-5, SS-X-6, 
and SS-N-8, with the SS-NX-13 due to be operational in 1976. 
(The SS-NX-13 ma}^ not be utilized as a strategic missile.) There 
are five primary submarine launchers: Golf (diesel), Hotel II and III, 
Yankee, and Delta (a long Delta will become operational in 1976). 
The latter four submarines are all nuclear powered. The U.S.S.K. is 
also developing a new large and small SLBM for deployment in the 
197S-79 period. The large missile will be the first Soviet SLBM with 
MIRV capabilities. 

U.S. SLBMs are the Polaris A-3 and Poseidon; the Trident will 
become operational in 1979. Included in the U.S. figures are approxi- 
mately 41 submarines carrying a total of 656 SLBMs with eventual 
capacity of 750-plus with the addition of Trident submarines. Both 
Trident and Poseidon have a MIRV capability. 

The range capability of SLBMs is extremely important because it in- 
creases the patrol area for an adversary's anti-submarine warfare 
(ASW) fleet and makes their search problem more severe. The range 
capabilities of current United States SLBMs exceed capabilities of 
Soviet SLBMs except for the SS-N-8 and the two Soviet SLBMs 
currently in development. The range of the SS-N-8 (4000+ nautical 
miles) exceeds all existing submarines. The range of the Trident when 
fully operational will exceed that of all other SLBMs. 

The Trident submarine and missile are the major items in the DoD 
FY 1977 budget associated with the SLBM program: 


[Costs in millions of dollarsl 


and FY Bevond 

prior FY 76 FY 77 78-81 FY 81 Total 



Cost 4,060.1 (983.1) 1,261.9 5,650.1 241.8 11,213.9 

Quantities 4 (1) 1 6 11 

Trident missiles: 

Coat 2,893.1 (942.6) 1,671.1 4,618.5 966.4 10,149.0 

Quantities 600 + 


Strategic Bomber Forces 

The Soviet bomber force consists primarily of the Bison and Bear 
bombers and the Backfire bomber, particularly for the future U.S.S.R. 
bomber role. The Bison is also utilized as the primary tanker aircraft. 
To date, the Backfire has been deployed primarily with U.S.S.R. 
naval forces. It has the ability to reach the United States. The 
U.S.S.R. bombers are armed with the Kangaroo and Kitchen air-to- 
surface missiles (ASMs) and with stockpiled nuclear bombs. 

The U.S. bomber force consists of 70 FB-llls and approximately 
350 B-52s. The KC-135 represents the major tanker capability. 
Congress will decide this year whether to proceed with production 
of the B-l. The DoD FY 1977 budget provides funding for the initial 
buy of three B-l production aircraft and long lead funding of eight 
FY 1978 aircraft. Current policy provides for an ultimate force of 
240-plus B-l aircraft. Assuming a favorable decision, the B-l would 
become operational in significant numbers in the 1980's. Besides 
nuclear bombs, weapons to be carried by the B-l and B-52 include 
the already deployed short-range attack missiles (SRAM) and the 
air-launched cruise missiles (ALCM) currently under development. A 
new buy of the SRAM missile is planned to provide B-l armament. 
There are also advanced procurement funds in the FY 1977 budget 
for an advanced tanker cargo aircraft (ATCA) with production to 
initiate in FY 1978. The ATCA will become the primary tanker for 
the B-l and also be used for tactical forces purposes. Cost and quanti- 
ties associated with strategic bomber forces and related systems in 
the FY 1977 budget are: 


[Costs in millions of dollars] 



FY 77 FY 78-81 FY 81 Total 

2,839.8 (660.5)l,o32.2 10,000.0 7,046.4 21,419.0 
3(R&D) 3 105 133 244 

(3. 0) 36. 3 838. 4 402. 3 1, 280. 
1, 124 896 2, 020 

121.0 (50.1) 79.2 260.0 460.9 




SRAM (B-l 

procurement) : 1 



missile: 2 



Advanced tanker/ 
aircraft: 3 




prior FY 76 

8.2 (5.2) 

45. 2 2, 847. 8 

(<) 2, 901. 2 

1 Previous SRAM procurements were for FB-111 and B-52 aircraft. 

2 The costs for the Air-Launched Cruise Missiles (ALCM) are R. & D. costs 

3 Funded under general purpose forces. 

4 Costs extend beyond FY 81. 



The U.S.S.R. has far more strategic defensive forces than the 
United States, but the numbers are offset by the greater capabilities 
represented by U.S. low-altitude bombers and missiles. The Soviets 
have deployed strategic defensive forces because the U.S. strategic 
bomber force has always represented such a powerful threat in the 
U.S.S.R. The United States has significantly reduced its surface-to- 
air missile (SAM) and interceptor aircraft forces. Conversely, the 
U.S.S.R. has increased SAM development, particularly for low- 
altitude defense purposes. These efforts may produce some capability 
for defense against the SRAM and ALCM. There will be a slight 
reduction in U.S.S.R. interceptor aircraft although capability is pro- 
jected to improve. Many of the deployed U.S.S.R. air defense systems 
were originally designed to counter medium- to high-altitude bombers 
and standoff threats imposed by the B-70 and its related technologies 
in development a decade ago. 

Approximate 1975 figures for U.S. and U.S.S.R. are: 




Interceptor aircraft 



SAM Launchers __ 

1 9,600 

1 These launchers accommodate about 12,000 SAM interceptors. 

Major items in the DoD FY 1977 budget associated with strategic 
defense forces and command and control S3 r stems related to strategic 
forces are (a) ballistic missile defense (R&D efforts, and technological 
improvements in sensors, data processing, radar, etc.), and (6) Ad- 
vanced Airborne Command Post (AABNCP). 


[Dollars in millionsl 

FY 76/ 
7T and 

prior FY 76 FY 77 

FY Beyond 
78-81 F Y 81 


Ballistic missile 

$459. 7 ($197. 2) $225. 


Costs $288. 9 ($42. 0) $98. 7 

Quantities 4 

$241. 2 Continuing 

$514. 8 

902. 4 

1 Fiscal year 1978. 


The primary purpose of theater nuclear weapons is to complement 
general purpose forces and act as part of a spectrum of deterrence and 
control of escalation. The theater nuclear forces of the U.S.S.R. land 
force consist of the SS-4 and SS -5 medium-range and intermediate- 
range ballistic missiles (MRBMs and IRBMs), and the Scud, Frog, 
and Scaleboard tactical missiles and rockets. Testing is being con- 
ducted on the SS-X-20, a MIRVed mobile IRBM. Several of the 


U.S.S.R. tactical aircraft and a great number of their naval forces 
also are capable of tactical nuclear delivery, although the number of 
weapons is unknown. 

U.S. theater nuclear forces are oriented toward nuclear-armed 
strike aircraft, atomic demolition munitions (ADMs), tactical surface- 
to-surface missiles (SSMs), and cannon artillery. Pershing, Lance, and 
Honest John are principal SSMs with the 8-inch and 155 mm cannon 
artillery comprising the nuclear artillery capability. The ASROC, 
SUB ROC, Terrier, and Talos are basic naval force theater nuclear 

The Navy- missiles have already incurred major procurement costs 
and the strike aircraft FY 1977 implications are discussed under 
tactical aircraft on page 162 of this study. There are several efforts 
underway to enhance theater nuclear force capability. None of the 
efforts have major impact on the FY 1977 budget. 

The following chart illustrates the relative strengths of U.S./ 
U.S.S.R. strategic and tactical nuclear capabilities: 






Totals: 2,210 2,490 





Strategic Delivery 









Strategic Warheads* 

Tactical Nuclear 

* These are approximate numbers. Estimates for certain types of 
U.S.S.R. tactical warheads are unknown. 






Northern and Central 

NATO Pact 

Combat/support personnel 625, 000 895, 000 

Divisions (does not include Reserves) 44 108 

Tanks 7, 000 19, 000 

Tactical aircraft 2, 300 2, 900 

MRBM/IftBM 583 

Mediterranean flank 

NATO Pact 

Combat/support personnel 575, 000 345, 000 

Divisions 39 31 

Tanks 3, 500 7, 250 

Land-based aircraft 733 655 

Carrier aircraft 200 

1 A study by the Library of Congress, Congressional Research Service, " United 
States/Soviet Militant Balance," January 1976. 



United States U.S.S.R. 

Personnel (approximate) 

2, 000, 000 1 3,000,000 
M9 -56-60 
9, 000 42, 000 
6, 000 19, 000 
190 220 
~ 80 260 
6, 500 6, 500 
9, 000 2, 500 



Major comb, 
Attack subm 
Tactical aire 

itant . 


1 Docs not include para-military forces. 

2 These figures represent full active division units. The United States also 
maintains 8 complete reserve divisions; the U.S.S.R. maintains another 100 to 
I 10 divisions ranging from one-third to two-thirds full divisions. 

U.S. divisions average approximately 16,000 troops; Soviet divisions average : 
Tank division, 9,000; motorized rifle division, 11,500; airborne division, 7,200. 

Tank Forces 

Current U.S.S.R. tank forces number approximate! v 42,000 and 
consist of the JS 2/3, T-10, T-54, T-55, T-62 and T-72 (the newest 
tank model with significant increased mobility, laser ranj^e finder, 
and better armor protection). The tank forces are augmented by a 
similar number of armored fighting vehicles. 

U.S. medium tank forces (9,000) consist of the M-4S, M-60, and 
M-60A1. Some M -48s are being upgraded to M-60 capability in onus 
and engine. 


The M-60A1 is undergoing a product improvement program to 
incorporate a series of system enhancements in mobility, firepower, 
etc. In addition to this effort, the XM-1 tank is being designed and 
will provide improved armor protection and cross-country agility. 
The mechanized infantry combat vehicle (MICV) under development 
as a replacement for the M-113 armored carrier in some units will 
be used to complement the tank force for mobile combat purposes. 
Major items in the budget associated with tank forces are: 

Table 9.— U.S. TANK FORCES 

[Costs in millions of dollars] 


and FY Bevond 

prior FY 76 FY 77 78-81 FY 81 Total 

M-48 i. 

(99.9) 61.9 310.2 






Quantities . 







2,239.4 (511.3) 571.0 1,573.4 
8,096 (800) 926 1,715 



549.7 (61.1) 89.4 



4 , 445 . 7 






22 , 489 

1 A significant number of M-48 tanks were purchased prior to FY 76. These 
totals represent costs for current M-48 modernization program. 


The number of U.S.S.R. artillery pieces and heavy mortars are dou- 
ble those of the United States. Recent Soviet developments indicate 
a change from towed field artillery systems to self-propelled systems. 
The new systems are the 122 mm SP Gun M-1974 and 152 mm SP 
Gun M-1973. The U.S.S.R. also has a series of surface-to-air missiles 
(SAMs), the SA-4, SA-6, SA-8, and SA-9. The Soviets deploy three 
anti-tank missile systems, the Snapper, Sagger and Swatter, which 
have ground/vehicle and /or helicopter firing capacity. 

U,S. artillery and SAM development and procurement focuses 
primarily on the cannon-launched guided projectile (CLGP), SAM-D, 
Roland II, and Stinger. As SAM-D, Roland II, and Stinger enter 
the operational inventoiy, they will replace older systems such as the 
N ike-Hercules, Hawk and Improved Hawk, Chaparral, Redeye, and 
Vulcan. Basic anti-tank systems are the TOW and Dragon. A non- 
nuclear version of the Lance missile is proposed in the budget. The 
M-109A1, XM-204, and XM-198 are three howitzers with significant 
expenditures over the next few years. New U.S. air defense artillery 
developments are geared at providing all-weather, 24-hour, low- 
altitude capability and other system enhancements. Major items in 
the budget associated with artillery weapons are: 


Table 10.— U.S. ARTILLERY 

[Costs in millions of dollars] 


and FY Bevond 

prior FY 76 FY 77 78-81 FY 81 Total 


Cost 45.6 36.1 497.6 660.4 1,239.7 

Quantities 120,000 


Cost 1,027.5 (130.3) 180.0 1,346.6 3,372.5 5,931.6 

Quantities 5,000- 


Cost 87.1 (55.0) 85.0 537.5 428.9 1,138.5 

Quantities 5,000- 


Cost 116.7 (23.4) 71.5 504.3 227.5 920.1 

Quantities 30,000- 

Chaparral : 

Cost 414.4 (42.4) 65.8 65.9 546.1 

Quantities 11,000- 

Improved Hawk: 

Cost 914.9 (102.4) 107.1 138.0 1,160.1 

Quantities 5,000- 


Cost 951.8 (152.2) 109.2 106.6 1,167.6 

Quantities 150,000- 


Cost 514.9 (146.7) 113.7 298.6 148.3 1,075.5 

Quantities 130,000- 

Lance (non- 
nuclear) : 

Cost 75.7 79.6 155.3 

Quantities 600- 


Cost 29.8 (4.1) 17.3 140.4 577.3 764.8 

Quantities 20,000- 

M-109A1: 1 

Cost 46.8 190.6 237.4 

Quantities 500 


Cost 32.8 (14.0) 8.1 181.8 28.3 251.0 

Quantities 1,600 — 


Cost 54.2 (12.0) 16.6 175.3 246.1 

Quantities 800^- 

1 Figures represent current product improvement program only. 




The U.S.S.R. helicopter force lags substantially behind the U.S. 
force, 9,000 to 2,500. There are currently two major U.S.S.R. models, 
the HIND A (assault) and MI8/HIP (transport) helicopters. The 
United States is adding to its current helicopter force by developing 
the advanced attack helicopter (AAH) (ultimate inventory objective 
is 472) and utility tactical transport aircraft system (UTTAS) (ulti- 
mate inventory objective is 1100) for anti-tank and assault and 
transport purposes. The AAH will carry the Hellfire anti-tank 
missile and be an all-weather helicopter. Each of the two new heli- 
copters have significantly improved performance criteria as a major 
system objective. Also in development is an advanced scout helicopter 
(ASH) for observation purposes. The AH-lJ is undergoing moderni- 
zation to prolong inventory life and accept the TOW missile. An 
extended range version of this helicopter is designated the AH-lS. 
Major items in the budget associated with helicopter acquisition are: 

Table 11. — U.S. HELICOPTERS 

[Costs in millions of dollars] 


and FY Beyond 

prior FY 76 FY 77 78-81 FY 81 Total 


Cost 196.5 (55.5) 112.1 993.1 1,575.8 2,877.5 

Quantities 100 372 472 


Cost 350.4 (91.9) 213.0 1,085.5 1,674.5 3,323.4 

Quantities 15 359 733 1,107 


Cost 12.7 (5.0) 26.0 

Quantities (*) (0 

AH-lJ Cobra-TOW: 

Cost 802.5 (59.6) 128.9 257.5 1,188.9 

Quantities 1,237 (30) 105 165 1,500 

Program scope currently under review. 

Naval Forces — Surface Combatant Ships 

The U.S.S.R. has made significant strides in combatant ship quanti- 
ty p overtaking the United States by a slight margin in major surface 
combatants. Geared for flexibilit}^ with relatively new, well-armed, 
high-speed ships, the Soviet fleet is equipped with both offensive and 
defensive missile systems and modern electronic warfare capabilities. 
Particular emphasis is on anti-submarine warfare (ASW) and anti- 
ship missile capabilities. The composition of the force will soon consist 
of a missile ASW carrier, guided missile and gun cruisers, missile and 


gun destroyers, and escorts. The Kiev-class aircraft carrier now 
nearing deployment will be the largest combatant developed in the 
U.S.S.R. Other current development or modernization efforts are 
for the Kara and Kresta II guided missile cruisers, the Krivak guided 
missile destroyer, and the Kashin guided missile frigate. All are 
equipped with ASW and/or SAM capability. 

U.S. surface combatant ship capability centers on a mixed force of 
carriers, cruisers, guided missile and gun destroyers, and guided 
missile frigates and conventional frigates. This force is highly speci- 
alized to support carrier task force operations and protect resupply 
convoys. Consequently, emphasis has been placed on anti-submarine 
warfare (ASW) capabilities for escort ships. Carrier aircraft are in- 
tended to defend escorts from enemy surface ships and aircraft, and to 
support combat operations ashore. The current development strategy 
emphasizes high-speed, well-armed ASW, and anti-ship missile 
forces, a feature sought by the U.S.S.R. among its ships. 

The United States plans to maintain a force of at least 12 attack 
carriers through the next decade. Current developments envision 
plans for a new class of carrier to replace the Midway /Forrestal class, 
new nuclear-powered strike cruisers, AEGIS destroyers, new patrol 
frigates, and surveillance ships. The AEGIS missile system for air- 
craft and missile detection, the HARPOON missile and sea-launched 
cruise missiles are the major equipment programs under development 
and production. Other armament acquisition efforts underway in- 
clude the CAPTOR, improved MK46 torpedo, PHALANX, and 
standard missiles. A land-based system engineering development site 
is being constructed to support AEGIS thip development. 

The DoD FY 1977 budget requests acquisition of 16 ships (4 sub- 
marines and 12 surface ships). The submarines are discussed in Sub- 
marine-Launched Ballistic Missiles (page 150) and Attack Submarine 
Forces (page 160). The 12 surface ships in the budget are eight guided 
missile frigates and one each of an AEGIS destroyer, fleet oiler, 
destroyer tender, and submarine tender. The budget seeks for full- 
funding of a conventionally powered destroyer and long lead time 
funding for the nuclear-powered strike cruiser with its authorization to 
be in the FY 1978 budget. A total of eight conventional and two 
nuclear AEGIS ships are planned over the next 5-year period. The 
5-year projections of the guided missile frigate total 40 ships. Major 
costs in the budget for surface ships and related programs and equip- 
ment include the following: 


Table 12.— U.S. SURFACE SHIPS 

[Costs in millions of dollars] 

7(3 7T 

and FY Bevond 

prior FY 76 FY 77 78-81 FY 81 Total 

AEGIS-Nuc Strike 
Cruiser : 

Cost 33.8 (15.6) 203.3 2,428.7 ■ 98. 8 1 2, 764. 6 

Quantities 2 2 


Cost 1 20.2 (15.5) 869.5 4,038.0 1 114. 1 5, 041. 7 

Quantities 1 7 8 

Guided Msl Frigate: 

Cost 1,384.6 (964.0) 1,288.5 5,338.4 464.1 8,475.6 

Quantities 10 (6) 8 32 50 

Destroyer Tender: 

Cost 395. 1 (266. 7) 315. 3 606. 4 30. 7 1, 347. 5 

Quantities 2 (1) 1 2 5 

Sub. Tender: 

Cost 290. 5 (.5) 263. 2 15. 15. 7 5S4. 4 

Quantities 2 1 

Fleet Oiler: 

Cost 245. 9 (240. 0) 102. 8 792. 5 55. 1 1, 196. 3 

Quantities 2 (2) 1 5 8 


Cost 8. 5 (5. 7) 11. 5 1 3, 750. 4 « 3, 770. 4 

Quantities 2 2 

T-AGOS Surveil- 

Cost .4 .3 .5 391.9 18.6 411.4 

Quantities 12 12 


Cost 51. 6 (45. 0) 80. 9 « 80. 3 1 212. 8 


1 Unspecified development and procurement continues beyond last FY period 



[Costs in millions of dollars] 


and FY FY FY Beyond 

prior 76 77 78-81 FY 81 Total 


Cost 583.7 (155.9) 186.0 656.9 1,426.6 

Quantities 2, 000 + 


Cost 174.9 (93.7) 182.5 1 514. 9 1 872. 2 



Cost 149.0 (33.1) 73.0 463.3 113.9 799.2 

Quantities 1, 200 + 


Cost 25.3 (11.2) 8.4 372.3 116.3 522.3 

Quantities 4, 000 + 

Phalanx : 

Cost 96.6 (15.0) 38.9 330.4 279.3 745.2 

Quantities 250 + 

Standard Missile 

(Extended range) : 

Cost 410. 4 (69. 3) 55. 1 495. 3 960. 8 

Quantities 4, 000 + 

Standard Missile 

(Medium range) : 

Cost 357. 6 (44. 5) 53. 5 331. 7 742. 8 

Quantities 4, 000 + 

AEGIS System: 

Cost 503. 9 (65. 9) 26. 3 57. 587. 2 


1 Unspecified development and procurement continues beyond last FY period 

Attack Submarine Forces 

Some Soviet attack submarines have only torpedoes for offensive 
weapons while others also have cruise missiles. The U.S.S.R. sub- 
marine force of about 250 attack submarines is the largest in the 
world; over one-half of the fleet is diesel-powered. Current U.S.S.R. 
development efforts for attack submarines focus on the Charlie-, 
Victor-, and Alfa-class nuclear-powered ships. The Foxtrot and 
Tango are the most significant conventional-powered submarines. 

Cruise missile submarines include the Echo-, Charlie-, Papa-, and 
Juliett-class ships. Charlie has capability for submerged launch of 
SS-N-7 cruise missiles. New ASW missiles, the SS-N-15 and SS- 
NX-16 are thought to be capable of launch from a variety of the 
new Soviet attack submarines. 

The U.S. attack submarine force will consist of a mixed force of 
nuclear- and conventional-powered submarines with major emphasis 



on the nuclear-powered ships. The SSN-688 (currently in develop- 
ment) with superior quietness and improved sonar capability is 
intended to be the basic U.S. attack submarine. A submerged launched 
variant of the HARPOON and the sea-launched cruise missiles 
(SLCMs) will provide cruise missile capabilities for the submarine 
force. The MK-48 torpedo will also be utilized on attack submarine 
platforms. The major items in the budget for attack submarines are: 


[Costs in millions of dollars] 


76/7T Be- 

and FY yond 

prior FY 76 FY 77 78-81 FY 81 Total 

5,492.5 (618.1) 1,337.5 2,773.5 92.5 9,696.0 
28 (2) 3 8 39 

1,226.8 (130.8) 144.3 579.8 42.2 1,993.1 
3, 000+ 







Tactical Aircraft Forces 

U.S.S.R. tactical aircraft fighter capability revolves around (a) the 
new generation MIG-21 Fishbed series, which doubles the weapons 
limit of previous versions and also extends its combat radius, (6) SU- 
17/Fitter C, with greater engine thrust and advanced avionics, (c) 
SU-19/Fencer-A, with a variety of guided and unguided air-to-ground 
missiles (AGMs), (d) MIG-23/Flogger, with increased performance 
package and armament over Fishbed, and (e) MIG-25/Foxbat B, 
with significant enhancements in altitude and speed. Primary U.S.S.R. 
aviation ordnance in future years will consist of the APEX, APHID, 
Kerry, and Kelt missiles. Estimated capabilities of these systems range 
from use against low-flying targets, use in short-range air superiority 
roles, and anti-radiation missile variants. 

Significant power has been added to the U.S. tactical air forces by 
recent additions of the A-10, F-14, and F-15 aircraft. The F-16 and 
F-18 air combat fighters, when they become operational in the late 
1970 and early 1980 timeframe, will further enhance U.S. air capability. 
Although quantities of U.S. tactical aircraft have diminished, the high- 
low mix of the new force is intended to bring sophisticated high per- 
formance to the force while maintaining force levels. This mix (F-14 
and F-15 with F-16 and F-18) has the dual objective of air-to-air 
combat and air-to-ground combat capabilities. 

Augmenting the newer aircraft are the older F-4, F-lll, A-7, 
A-4M, and AV-8A, a vertical/short take-off land aircraft (V/STOL). 
The AV-8A will be phased out of the inventory by the new V/STOL, 
AV-8B). The F-lll will also be modernizing a portion of its fleet to 
an EF-lllA configuration for electronic countermeasure jamming 
purposes. The A-6E will continue as an all-weather attack aircraft. 
The E-3A airborne warning and control system (AW ACS) will pro- 
vide all-altitude surveillance and command and control capability. 


It isjscheduled to become operational in CY 1976. The A-10, armed 
with Maverick missiles and laser-guided weapons, is being produced 
as a specialized close-air support aircraft. The Sparrow, Sidewinder, 
Shrike, Condor, Phoenix, and Harm (in development) missiles will 
provide a sizeable air-to-air-missile (AAM) and air-to-surface missile 
(ASM) capability for tactical air purposes. 

There are many U.S. tactical air programs with significant acquisi- 
tion costs proposed in the FY 1977 budget. Major items are: 


The Air Force intends to initiate a buy of F-16 aircraft with a 
planned inventory of 650. Four NATO nations have signed a memo- 
randum of understanding to eventually purchase 306 F-16s with op- 
tions to buy 348. A total of 108 F-15s (planned inventory 729) are 
in the budget; 100 A-lOs (planned inventory 700-plus); and 6 E-3A 
AW ACS (planned inventory 31). Major proposed FY 1977 funding 
includes : 


[Costs in millions of dollars] 

FY 76/ 

7T and FY Beyond 

prior FY 76 FY 77 78-81 FY 81 Total 
















F-4/F-111 Mods: 



317. 4 (215. 7) 619. 7 4, 791. 8 325. 8 6, 054. 5 
16 589 45 650 

6, 092. 4 (1, 602. 4) 1, 540. 4 3, 795. 6 11, 428. 4 







1, 036. 3 

(457. 1) 


617. 8 

2, 550. 7 


1, 833. 

(464. 6) 

584. 3 

1, 337. 8 


64. 1 


36. 8 


814. 7 

(259. 2) 

262. 5 

1, 183. 2 


622. 2 



TheTNavy budget proposes developmental effort on the F-1S to 
serve as a lower cost complement to the F-14 and replace the F-4/A-7 
aircraft. Anticipated inventory objective is 800 aircraft. There is 


also continued procurement of an additional 36 F-14s to the current 
inventory of 267 aircraft (planned inventory objective 391). Major 
budget proposals, are : 


[Costs in millions of dollars] 


76/7T FY Bevond 

and prior FY 76 FY 77 78-81 FY 81 Total 

A-6 Mod to A-6E: 1 

Cost 300. (300. 0) 167. 9 614. 9 1, 082. 8 



Cost 2,021.4 (178.4) 235.4 841.4 3,098.2 

Quantities 542 (30) 30 120 692 


Cost 5, 323. 4 (621. 4) 708. 2 2, 194. 6 8, 226. 2 

Quantities 279 (36) 36 88 403 


Cost 152.9 (110.3) 346.9 4,059.2 8,272.1 12,831.1 

Quantities 117 683 800 


Cost 295.7 (12.7) 102.4 63.3 461.4 

Quantities 120 21 3 153 

P— 3C ' 

Cost 2,053.9 (172.3) 241.9 1,331.5 3,627.3 

Quantities 157 (12) 12 64 233 


Cost 1,162.0 (161.4) 170.9 512.1 1,843.8 

Quantities 43 (6) 6 18 67 


Cost 1, 460. 1 (115. 5) 139. 9 381. 5 1, 981. 5 

Quantities 66 (6) 6 18 90 


Cost 77. (22. 0) 44. 2 416. 1 537. 1 

Quantities ( 3 ) 


Cost 104. 1 (26. 3) 83. 2 1, 406. 5 1, 593. 8 

Quantities 200 200 

1 Includes current modifications of A-6 to A-6E configuration. 

2 Does not include potential costs beyond FY 1981. 

3 Quantities undetermined. 


Major proposed FY 1977 development and procurement efforts 
for both Navy and Air Force tactical air missiles are: 


[Costs in millions of dollars] 

FY 76/ 

7T and FY Bevond 

prior FY 76 FY 77 78-81 FY 81 Total 


Cost 767.9 (143.7) 156.4 632.0 417.5 1, 973. S 

Quantities 25, 000 + 


Cost 252. 7 (94. 5) 93. 2 366. 74. 9 782. 6 

Quantities 17, 000 + 

Phoenix : 

Cost 848. 5 (101. 2) 84. 370. 6 1, 303. 1 

Quantities 2, 500 — 

Shrike: 1 

Cost 543. 3 (47. 0) 51. 3 217. 8 812. 4 

Quantities 30, 000 + 


Cost 369. 5 (91. 0) 12. 7 180. 2 561. 4 

Quantities 980 + 

Harm : 1 

Cost 64. 4 (27. 7) 33. 5 498. 3 596. 2 

Quantities 3, 800 + 

Maverick Laser: 

Cost 36.3 (16.6) 59.3 213.9 309.5 

Quantities 4,500 + 

Maverick (Imaging 
Infra-red) : 1 

Cost 8. 2 (8. 2) 24. 621. 1 658. 3 

Quantities 9, 600 + 

1 Does not include potential costs beyond FY 1981. 

Airlift/Sealift Forces 

U.S. airlift/sealift forces provide capability to move forces rapidly 
to overseas theaters, meet commitments, and maneuver material in 
CON US and overseas. The forces are separated into strategic and 
tactical airlift forces. Current strategic airlift capabilities revolve 
around the C-5A and C-141 military airlift fleets, which would be 
augmented by Civil Reserve Air Fleet (CRAF) aircraft under mobili- 
zation conditions. DoD plans to rebuild the C-5A wings, stretch the 
C-141, and modify a portion of the CRAF to increase its military 
cargo capacity. Tactical airlift capabilities revolve around the CH-63, 
US-3A carrier on-board delivery aircraft, Cli-47 modification pro- 
gram, and the new development of the advanced medium STOL 
transport (AMST). Major items in the budget for airlift/sealift 
forces are: 



[Costs in millions of dollars] 


and FY Bevond 

prior FY 76 FY 77 78-81 FY 81 Total 

CH-47 Mod: 

Cost 18. 9 ( 10. 0) 25. 9 338. 7 967. 1 1, 350. 5 

Quantities 361 361 


Cost 24.3 (15.2) 170.9 199.7 394.9 

Quantities 12 18 30 


Cost 121.3 (10.5) 116.3 389.0 626.6 

Quantities 4 10 60 74 


Cost 207. 2 (84. 9) 29. 3 1 90. 1 326. 5 

Quantities ( 2 ) 

C-5A Wing MOD: 

Cost 405.0 (22.3) 22.6 500.1 528.7 1,091.9 

Quantities 38 38 76 

C-141 Stretch 

Cost 41.5 (16.5) 601.3 38.1 680.9 

Quantities 274 274 


Cost 29. 3 463. 1 307. 6 800. 

Quantities 6 75 29 110 

1 Does not include all potential costs beyond year specified. 

2 Quantities have not been specified. 


Both the U.S. and U.S.S.R. maintain a large contingent of forces 
and weaponry in the Western Pacific/Eastern Asia region. The Soviet 
buildup consists of 28 army divisions added to the forces over approxi- 
mately the past 15 years. This buildup is a direct result of concern over 
the Sino-Soviet split during the 1960's. Altogether, the U.S.S.R. main- 
tains 43 divisions and 2 brigades along the Chinese border and on 
Sakhalin Island and the Kamchatka Peninsula. These forces are 
geared for action against China. The Soviet naval force consists of 
strategic and attack submarines and surface ships. Its air force con- 
sists of approximately 1,700 combat aircraft. 

The presence of U.S. troops in the Pacific area is intended to deter 
hostilities, to maintain a stable military and political balance, and to 
honor commitments to allies. U.S. forces deployed in the Western 
Pacific area are comprised of 1 Army division, the equivalent of 1 
Marine division, 9 tactical aircraft squadrons, 2 carrier task forces, 
and patrol aircraft squadrons. Forces stationed in Hawaii include an 
additional Army division and a tactical aircraft squadron. Forces 
based in the Western United States could augment these deploj-ed 
forces but are not maintained exclusively for an Asian contingency. 
Major U.S. force commitments in the Pacific are located in Hawaii, 
South Korea, Guam, Japan, including Okinawa, and the Philippines. 



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